Retirement planning is a major part of a responsible personal finance strategy – one that is neglected by far too many people who don’t contribute enough while they are working. But even those who plan well for life after their earning years are living in an era of increasingly long life spans. The longer you live, the more difficult it becomes to plan for an extended life after retirement, which could be decades after you receive your last paycheck. For many, longevity insurance can mitigate the risk of running out of money during longer-than-planned retirement.
Longevity Insurance: The Basics
Sometimes called advanced life deferred annuity, longevity insurance provides lifelong income to retirees who live longer than their nest egg can support. This type of insurance generally kicks in when the recipient is around 80 or 85 years old. Longevity insurance works in the same way as deferred annuities, in that the buyer purchases the promise of future payments with an up-front buy-in, and the payment is calculated at the moment they purchase.
The takeaway is that it if you invest in longevity insurance, time is literally money. If you buy, say, a $20,000 policy when you are 55 years old, you will receive bigger payments for more years than you would have if you had made the same investment at 65 when you retire.
The Danger: Use it or Lose it
One of the biggest drawbacks to longevity insurance is that it comes with a big risk: If you die before the payments kick in, you lose the money you invested. If you live to be 150, the insurance company is on the hook to keep making payments. They mitigate this risk, however, by keeping whatever you don’t use – even if you die before your nest egg runs out.
New Rules Make Buying Easier
The Treasury Department recently adjusted their rules so that investors can direct 25 percent of their retirement savings, up to $125,000, into longevity insurance. Any amount of retirement contributions you direct to longevity insurance is exempt from Minimum Required Distribution (RMD) rules. Rates for annuities and policies like this are historically low, which could entice more people to purchase them, but as discussed before, the risk is a total loss of contributions that could have gone to heirs, charity or an estate.
Popularity Grows as Pensions Wane
Longevity insurance is a relatively new phenomenon. Its popularity is a direct result in the steep drop off in the number of retirees who have defined-benefit pension plans, which workers historically relied on to guide them through old age – even advanced old age. Today, pensions have largely been replaced by 401(k)s, which people can budget for their years after work, but only for so many years. Deferred annuities take fill the void that was historically satisfied by pensions.
Forbes calls longevity insurance a “longshot” that is actually more of a gamble than an investment. Many retirees purchase longevity insurance because they are afraid of the risk of outliving their savings and having to move in with their children, or worse, being indigent at an advanced age during a period of physical or mental decline. But statistically, so few people live past the age 85 that the greater risk may be forfeiting a large chunk of money that could have been handed to successive generations or spent during retirement. Only you can determine which risk is greater given your financial situation.