Last Updated Jul 15, 2010 5:19 PM EDT
Longevity Insurance: Protection from Retirement Poverty Fears
I am talking about longevity insurance. This is a deferred annuity with a very long deferral between when you purchase the policy and when it starts to pay out. The idea is that at around age 65 you purchase a policy that will only start to make monthly payments to you far down the line; age 85 is a typical start date for payments.
Hold on, you say? Might you be dead long before 85 thereby "wasting" the money you paid for this insurance? Well, sure. Then again, might you not? The actuarial tables tell us that half of today's 65-year-olds will still be very much alive in their mid-80s. And as the EBRI study makes quite clear, it's the later years of retirement where running out of money becomes a more ominous threat. Keep in mind that the chart below refers simply to minimum retirement income needs-for food, shelter etc. If EBRI were to add in discretionary costs-travel etc-the numbers would be a lot worse.
As financial advisor par excellence Harold Evensky once mentioned to me, "What keeps me up at night is the prospect that my clients may live a very long time, not that they are going to die." Longevity insurance is a compelling tool to consider when contemplating a long life. As Evensky recently told Morningstar:
I think the longevity insurance is a brilliant idea, and assuming it's reasonably priced, will probably be the single most important vehicle. You'll get a lot of bang for your buck if you live long enough to see a payout, and it provides a great deal of flexibility in the design of the balance of the portfolio.The flexibility Evensky refers to is the impact the longevity policy can have on how you plan and spend in the early years of your retirement. Because you know you will have a new pension payment kicking in at age 85 it allows you to invest and spend your money from 65-85 a bit differently. John Olsen, a St. Louis financial adviser specializing in estate planning says having a longevity policy has a direct impact on quality of life in retirement. "When you're scared of the imponderables [a very long life] you are going to spend less. You can end up shortchanging yourself because of that fear. Once you have a longevity policy you have the freedom to spend differently. Maybe you can go to Europe more often because you know there will be a new income stream to help you later on."
Because of the odds you may not be alive to collect, it takes a relatively small sum of money to purchase a chunk of late-life income insurance. Rather than tie up the bulk of your assets in a traditional annuity that might start payouts at age 65 or so, you typically would need to annuitize just 10 percent to 15 percent of your assets at age 65 to lock in a solid longevity payout down the line. (You can check out some examples of how annuitizing just 10 percent or so of your assets in a longevity policy in your 60s can buy you a strong income stream in your 80s.) Meanwhile you keep total control of the other 85 percent to 90 percent of your assets, retaining liquidity and the potential to pass along assets to heirs.
It's Insurance, not an Investment
Olsen believes longevity insurance could redefine retirement planning,(PDF) but he says it has been frustrating to date to see insurance agents bristle at the fact that longevity insurance isn't a good investment.
He agrees, it isn't a good investment. But that's because it shouldn't be viewed as one. "We need to recognize longevity insurance is like property-casualty insurance. You don't expect a good return on investment on your homeowners or auto policy. You purchase it to protect you from a peril that scares you. If what scares the stuffing out of you is that you will be 90 and out of money, then longevity insurance may be worthwhile protection for you."
Only a handful of insurers have dived into the longevity pool to date, including MetLife, New York Life, The Hartford and Symetra. As with all insurance, you need to sharp smart. A policy only makes sense at the right price, and with the right features-some policies provide inflation riders but you need to weigh the cost (lower eventual payouts) and decide if it makes sense for your circumstance. And given that your payoff could be 20 years off, you want to stick with the most financial stable insurers.
I wouldn't be surprised if the same type of growth pains that have hit the LTC insurance market could come into play here too. But if you're in your 40s and 50s and beginning to sweat the ramifications of how you'll navigate a potentially long life, keep an eye out for longevity insurance. It can be a key tool to making sure you don't have to fear running out of money in retirement.