Wednesday, July 9, 2014

Longevity Insurance and Delayed Annuities

I learned something new this week about the difference between a Delayed Annuity and Longevity Insurance. I originally thought they were the same thing.  This is not true.

They are a potential solution to a retirement problem - what happens if I outlive my savings?  Those with good pensions do not have this worry as most or all of your retirement income is guaranteed for life but for the large number of people who have to finance their own retirement, outliving your nestegg is a real worry.  If you were 65 and retiring today, your average lifespan would be 82.5 years for a male.  But this is an average, so there is a pretty high likelihood that you will live longer, particularly with medical advances. Consider the increase in life expectancy at 65 shown in the graph below from the US Social Security Administration.  How to make sure you still have enough money when you are 85?

Most people understand an annuity.  You pay a lump sum to get monthly income, which could be for life, or for a set number of years.  Inflation which is unknown, will decrease the value of the monthly income.  For example, a $100,000 payment today might buy me a regular life annuity with a $600 per month payout for life.  You could buy one of those rare annuities with an increasing monthly payout but then the payout will be much lower.  The solution could be a delayed annuity or Longevity Insurance.

1. A Delayed Annuity is an annuity where you pay a lump sum today, and you start getting your payments at some time in the future.  If you die before the payout starts, your estate gets the premium back.  If you die after the payouts start, your estate could get nothing (life annuity) or a lump sum.

If I purchased a $100,000 delayed annuity today, with payments starting when I am 83, I would get $3200 per month starting when I reach that age - 5X the payment of an immediate life annuity ($600).  I ran the numbers and I would get about the same amount if I invested the $100K at 5%, then bought an annuity when I was 82.  So this is not very exciting or useful, in my opinion.

2. Longevity Insurance is like an annuity with a reverse insurance policy that pays off if you are alive after a period of time.  Recall that life insurance pays off if you die.  You pay a lump sum today to a company and if you are alive at a period of time in the future, you start getting payments.  If you die in the meantime, you and your estate get nothing.

If I purchased a $100,000 Longevity Insurance contract today, with payments starting when I am 85, I would get $6700 per month for the rest of my life.  This is double the amount I would receive if I bought a delayed annuity or just kept $100K aside and bought an annuity at 85.  It is 10X the payment of an immediate life annuity ($600).

So you may want to think about the problem of outliving your nestegg savings and these two solutions and consult your financial advisor.  I will  be giving it careful thought.

Life Expectancy of a 65 year old American by Calendar Year - SSA Report

1 comment:

  1. Life indeed is a journey that involves many changes along the way. Therefore, it is imperative to brace yourself for anything that it may throw at you. Successful people agree to the fact that success is a collision of preparation and opportunity.
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