Guaranteed income in retirement has emerged as a central issue for baby boomers, and fast becoming the solution of choice is something called longevity insurance. It’s a nifty product—but, as you might suspect, hardly flawless.
Few saw the retirement income crisis coming 30 years ago, when defined contribution plans such as the 401(k) began to replace defined benefits plans such as the traditional pension. The switchover was slow at first, but picked up steam in the 1990s and today most workers have only a 401(k)-type retirement account through their employer.
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It turns out that the 401(k) is deeply flawed as a stand-alone retirement savings vehicle. Sure, it allows for tax-deferred savings and growth. But with so much riding on the account’s growth most people invest in stocks, which can go through long dry spells and plunge on the eve of cashing out. That’s been the experience for many reaching retirement age the past few years.
Even if the accounts perform well, most retirees are unsure how to convert this critical asset into a lifetime income stream—such as was provided by the traditional pension. One common strategy is to drawdown your account balance by 4% a year. Studies show your money should last 30 years that way. But that takes a lot of discipline and still there are no guarantees.
Planners and policymakers have been looking for a way to replace the guaranteed income component of individuals’ nest eggs since the financial crisis, and even earlier. Immediate fixed annuities are one solution. But with interest rates so low few retirees can purchase enough fixed income through this product without handing over every penny they have.
Enter longevity insurance. This is basically an immediate fixed annuity that you purchase today but do not begin collecting on for, say, 20 years. The delay lets you purchase almost 10 times the income for the same price. An example cited by The Wall Street Journal: a 65-year-old man who plunks down $100,000 for an immediate fixed annuity would receive $6,950 a year for life. The same investment in a deferred immediate fixed annuity would not start paying until age 85 but would then guarantee income of $63,990 for life. With such an annuity in place a retiree could plan to draw down their accounts entirely over 20 years and then have secure income after that for as long as they live.
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Longevity insurance is catching on. The Treasury has rewritten certain rules to encourage such an option in 401(k) plans. Meanwhile, The Journal reports that sales of New York Life’s new deferred income annuity product have exceeded expectations by a factor of 10. Financial planners say a deferred immediate fixed annuity is perfect for the second bucket in a three-bucket retirement plan. Bucket one should be an immediate fixed annuity with a 10-year payout. Bucket two should be an immediate fixed annuity that you buy today but defer for 10 years and then collect on for either 10 years or life, depending on your needs. Bucket three, to be tapped in 20 years, should hold riskier assets like stocks and bonds.
Is longevity insurance right for you? There’s a good chance it is. It allows you to secure income for your much-later years with just a fraction of your portfolio today. The product is highly flexible; you can start your collection date in anywhere from one to 40 years and with each year you wait the monthly income grows. It makes planning much simpler because all that is left to figure out is income for a knowable period of time before you’ll start collecting on the annuity.
But understand that, in the end, deferred annuities are an insurance product. Unless you pay extra for certain guarantees, you and your heirs will never see a dime’s worth of payout if you pass away early, and if inflation spikes the income you bought might not be sufficient 20 years down the road. Still, longevity insurance addresses one of the 401(k)’s chief shortcomings—guaranteed income—and for many people merits a closer look.