I've recently heard about a new type of annuity called a longevity annuity. Can you explain what one is, how it works and whether I should consider buying one for my retirement? --Mike, Indiana
Longevity annuities have actually been around in various forms for a decade or more. They've been getting a lot more attention lately, however, because the U.S. Treasury Department issued rules last year that make it easier and more attractive to buy a certain type of longevity annuity within retirement accounts such as 401(k)s and IRAs.
But before we get to whether it makes sense to include a longevity annuity in your retirement income plan -- let me explain how longevity annuities work.
Essentially, a longevity annuity is a twist on a somewhat more familiar type of annuity, the immediate annuity. With an immediate annuity, you hand over a sum of money to an insurer in return for guaranteed monthly payments that start at once and continue for the rest of your life. (You can also opt for payments to continue as long as either you or your spouse or partner is alive.)
Like an immediate annuity, a longevity annuity provides guaranteed income for life, except that while you invest your money now, the payments don't begin until later, typically much later, say, 10 to 20 years in the future. In effect, buying a longevity annuity is a bit like buying a life insurance policy, but instead of making a payment to your heirs when you die, a longevity annuity makes monthly payouts to you for the rest of your life, assuming you're still alive when those payments are scheduled to begin.
Both immediate and longevity annuities provide a way to insure that you'll still have income flowing in no matter how long you live in retirement and no matter how the financial markets fare, important considerations given today's longer life expectancies and predictions for lower investment returns in the years ahead.
But a longevity annuity allows you to insure against the possibility of running out of money late in retirement while putting up less money upfront than you would with an immediate annuity, thus leaving you with more of your savings to enjoy earlier in retirement.
For example, a 65-year-old man who invests $100,000 in an immediate annuity today would receive roughly $565 a month for life. But a 65-year-old man could receive payments almost twice as large -- $1,100 a month -- by investing just $25,000 in a longevity annuity that would start making payments for life starting at age 85.
To see how much monthly income you might receive from both an immediate and a longevity annuity, check out this annuity calculator.
Of course, there is the risk that you could put some of your money into a longevity annuity and die before or shortly after payments begin, in which case you would receive no, or only a few, payments. But that doesn't necessarily mean investing in one was a bad decision any more than buying auto insurance was a mistake because you were never involved in a horrific car crash. (There are longevity annuities that pay your beneficiary any part of your original investments you didn't receive in payments. But the monthly payout is much smaller and by choosing this option, you're undermining the rationale for buying such an annuity in the first place.)
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So now that you have a better idea of how longevity annuities work, should you make one part of your retirement income plan?
Recent research suggests that longevity annuities can boost the retirement prospects of many Boomers and GenXers. But to decide whether one is right for you, there are a few things you need to consider.
One is longevity. If you're convinced you'll die before your life expectancy, then a longevity annuity -- or even an immediate annuity, for that matter -- would make little sense. Similarly, if your nest egg is large enough so that your chances of running through it in your lifetime are very low or negligible, then you also may not need any type of guaranteed income beyond Social Security, in which case you simply may not have to devote any of your assets to a longevity annuity or an immediate annuity.
You can get a sense of how long your nest egg is likely to last by checking out this retirement income calculator.
If, on the other hand, you feel you could benefit financially or emotionally from having more guaranteed lifetime income, then the question is what's the best way to get that income.
If you want the guaranteed income to begin soon -- say, to pay for essential living expenses beyond what income from Social Security alone will cover -- then an immediate annuity would be a better way to go (although you may still want to hold off a bit to get a better handle on what your actual expenses will be after you retire).
But if you're confident that you can handle your spending needs with Social Security and draws from your retirement accounts but you want some extra assurance that you'll have sufficient income later in life -- or you feel that future guaranteed income will give you more flexibility about your spending early on -- then devoting a small portion of your assets to a longevity annuity is probably the better way to go.
If you decide to go with a longevity annuity and plan to buy it within a 401(k), IRA or similar retirement account, make sure you go with one that meets the new Treasury Department regulations and has been designated a QLAC, or Qualified Longevity Annuity Contract. With a QLAC, you can invest the lesser of $125,000 or 25% of your 401(k) or IRA balance and delay payments to as late as age 85 if you wish. QLACs also provide a bit of a tax break -- i.e., you don't have to include the cost of the QLAC when calculating RMDs, or required minimum draws, which you generally must start taking from retirement accounts once you reach age 70 1/2.
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Before buying any annuity, you'll want to take time to shop around, compare quotes and take other steps to make sure you're getting good value for your annuity buck. And while you want to be sure that any investment you buy benefits you and not just the adviser selling it, that's an especially important consideration with annuities given the potential conflicts of interests highlighted in a recent report from the office of Senator Elizabeth Warren.
Bottom line: If you're concerned about running short of income late in retirement, a longevity annuity is worth considering. Just leave yourself lots of time to fully consider the pros and cons before you decide whether to commit.
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