Make sure to max out your ‘mortality credit card’
It’s difficult for most people to come to grips with their own mortality and the fact that, eventually, we will perish from this Earth.
As a good friend of mine in the life insurance business says: “One out of one of us is going to die.” This anti-motivational statement should remind us that time is fleeting, and so is that balance on the mortality credit card that is in your pocket.
What is a mortality credit?
Tom Cochrane is a good friend of mine who runs the educational site AnnuityDigest, and has a simple and easy way to understand the definition of mortality credits. He refers to it as mortality yield and a pure hedge against longevity risk. He also points out that mortality credits create a return that is almost impossible to match in the real world of investing.
Mortality credits increase as you get older, and the pooling of annuity money and aggregate life expectancies provide a higher yield due to this sharing of risk among that pool of lifetime annuity participants.
What is your current balance?
Everyone has a life expectancy, and lifetime annuity payments are primarily based on that actuarial number. Buying a lifetime income annuity is like betting with the annuity carrier that you are going to live longer than they predict. The value proposition is that regardless of how long you exceed their life expectancy prediction, they are on the hook to pay.
Life expectancy tables haven’t been adjusted for a while, and I think that potential change is as much of a risk to the consumer as perceived low interest rates. If the tables are changed in the near future as I predict, this would lower payments because your life expectancy would be longer.
What’s your poison … bonds or annuities?
Fellow RetireMentor and smart-guy-in-the-room Michael Kitces recently addressed the ongoing argument of which strategy is better (bonds or annuities) for retirement income.
His argument for the annuity choice is that the time horizon is known and highly predictable due to life expectancy tables and transfer of risk nature of the strategy. Bonds do work, but current interest rates make the creation of any laddering strategy a pretty heavy lift.
Kitces concludes that annuities do have the potential to produce a higher payout than a fixed-income portfolio, primarily due to the transfer of risk magic of mortality credits. He warns that trying to limit the downside by structuring legacy guarantees within your lifetime annuity actually defeats the purpose of the mortality credit value proposition. Translation: You can’t have your annuity cake and eat it too!
Cash advances on your card
All of us need a monthly income amount to live on, even those of you who are debt-free. The key is to set up an “income floor” so that you can never outlive that needed income stream. These flooring solutions could include Social Security payments, a pension (if so fortunate), bond or stock dividend portfolios, or a transfer of risk annuity income guarantee.
Annuities should primarily be used as an income-gap filler, or for future income start dates to combat potential inflation. If you feel like you don’t need either of them, then you don’t need an annuity. However, most people I speak with need at least one of those goals contractually taken care of to combat longevity risk.
So the next time you pull out your credit or debit card to pay for something, don’t forget that your mortality credit card is available to use as well. “Don’t leave home without it” was a campaign that we all remember to remind us to carry a specific company’s credit card. With your mortality credit card, the slogan is: “Don’t forget you have it, and don’t forget to maximize it.”
Originally published 4.7.15 by MarketWatch.com – http://www.marketwatch.com/story/make-sure-to-max-out-your-mortality-credit-card-2015-04-07