On July 1st, the US Treasury Department gave the green light for savers to convert part of their 401(k) or IRA balances into a longevity annuity.
Longevity Insurance (QLAC) is a type of deferred income annuity typically designed to begin paying an income stream once the annuitant (you) lives past 80 or 85. Basically, QLAC allows you to create an income stream that kicks in after you attain a pre-determined age in retirement.
You may be asking yourself, why would I need longevity insurance?
The simple answer is “longevity risk.” Today we are living longer and longer — and longevity insurance is one way of creating an income safety net that offsets the risk of outliving your savings in the final years of your life.
And now for the first time, longevity insurance is a menu option within tax deferred retirement plans. Effectively, the Obama administration has waived the requirement to begin withdrawals from tax deferred accounts such as a 401k and IRAs at age 70 ½ on the value of a QLAC policy.
The U.S. Treasury Department will also permit insurance companies to sell a limited number of add-on features. They include a rider that entitles a beneficiary to receive proceeds equivalent to the original premium paid by the annuitant should the annuitant die. Another feature will allow the annuitant’s spouse to continue receiving annuity payments after he or she dies.
These riders are designed to lower an annuitant’s risk, but they do come at a cost. Such add-ons will either increase policy premiums or reduce future payments.
Potential downside to purchasing longevity insurance:
· Guaranteed income comes at a price
· Up-front cost (a lump-sum premium payment will lower your available annual income during the first decade or two of retirement)
· You will not have access to savings allocated for the lump-sum premium payment
· If you die before you receive any income, your heirs may lose your initial lump-sum premium payment—unless you purchase a rider
· Fewer than 40% of 55 year olds will live to age 85
· Typically you will wait 20 years or more before you begin receiving benefits
· Inflation may erode the value of your future income
· The stock market may generate better returns, and thus could provide you with more income later in life.
Benefits of longevity insurance:
· Protects you from running out of money in retirement
· You can’t outlive your income regardless of lifespan
· Longevity insurance could offset long-term care expenses
· Guaranteed* future income provides the annuitant with greater comfort in making lifetime gift decisions to heirs and/or charities (*Guarantees are provided by the insurance carrier).
· Reduces the challenges and anxiety associated with managing the spend-down of retirement savings
· The value of a longevity insurance policy is excluded from Required Minimum Distributions prior to annuitization
· We feel QLAC policies purchased in a 401k plan are expected to be priced more aggressively than policies sold on the open market
Key considerations in determining whether to purchase LI:
· Life expectancy
· Given life expectancy, lifestyle, and their associated costs, project the number of years savings will be available to meet annual expenses
· Inflation (average historical annual inflation rate is approximately 3%)
· Inflation adjusted rate of return on retirement savings
· Expected Social Security and pension income
· Compare income generated from a longevity insurance policy to that of a portfolio of stocks and bonds, a variable annuity, and/or one or more immediate annuities
· The cost of the QLAC policy
· Current market interest rates (QLAC benefits are based on current market interest rates)
· Estate plan
So, does it make sense to purchase longevity insurance? It depends on your circumstances.
If you fear your savings might run out by the time you turn 85 and you aren’t worried about leaving money to your heirs, then you might want to allocate a portion of your savings to create future income that will kick in say 20 years from now, then you may want to consider a QLAC. Given the ups and downs of the stock market, QLAC is one of a few products that may offer you the promise of stability and security in the final years of your life.
Finally, be aware that timing your purchase based on current market interest rates will impact your future benefits. Keep in mind, too, that the longer you wait to receive your benefits, the greater your future income will become. And don’t forget that Social Security and pension benefits are complimentary sources of longevity insurance.