Two of the most frequently asked question that I receive are “How does longevity insurance work?” and “How much does longevity insurance cost?”
Solving for longevity risk is making sure that you will never be running out of money and that you have a sufficient lifetime income stream hitting your bank account regardless of how long you live. Having enough guaranteed retirement income is front and center in most people's minds and especially those 10,000+ baby boomers that reach retirement age every single day. The cost primarily depends on your life expectancy at the time you start the lifetime income payments, with interest rates playing a secondary pricing role.
There’s only one financial product type that can contractually solve for longevity risk. Yes, it’s that hated financial word…annuity. Facts are facts, so let’s take a closer look to see if a longevity annuity might be a fit for your specific situation.
Annuities have a monopoly on lifetime income, and therefore have a monopoly on being the only legitimate solution for longevity risk. Any serious retirement plan has to address the real concern of outliving your money.
So “How does a longevity annuity work?” In essence, a longevity annuity is a transfer of risk strategy that solves for lifetime income. It’s a long term fixed income annuity that is issued by life insurance companies. A longevity annuity is a contract between you and that issuing carrier, with the annuity company being on the hook to pay regardless of how long you live.
Longevity annuity payments are primarily priced on your life expectancy (or life expectancies if “joint”) at the starting date of those annuity payments. The interest rate portion of that payment plays a secondary pricing role.
All longevity annuity payments are a combination of return of principal plus interest, and you can contractually structure the policy so that any unused money upon your demise will go to your listed beneficiaries as a death benefit.
So is a Longevity Annuity an actual product or an overall strategy? The answer is yes. It’s both.
Annuities were first used during the Roman Times as a pension lifetime income payment for the dutiful Roman Soldiers and their families. That first annuity solved for longevity risk just like all income annuity types do today.
Below are the annuity product types that contractually solve for longevity risk, and can be legitimately categorized as a longevity annuity structure. All of these can be structure to cover for one life (Single Life) or two lives (Joint Life).
Single Premium Immediate Annuity (SPIA) - Lifetime income can start as early as 30 days from the policy being issued, up to one year.
Deferred Income Annuity (DIA) - Lifetime income can start as early as 13 months from the policy issue date to as far out as 40 years with some carriers.
Qualified Longevity Annuity Contract (QLAC) - This is a DIA structure that can only be used inside of a Traditional IRA or other approved qualified accounts. Income can typically start as soon as your early seventies, and can be deferred ast far out as age 85. In other words, you don’t have to defer out to 85, but that is as far as the IRS will allow you to defer before you are required to start the payments. Even though the new RMD age is 72, many people choose to start their QLAC payments at age 70 or earlier.
Income Riders also solve for lifetime income, and those can be attached at the time of application to some Variable Annuities (VAs) and Fixed Index Annuities (FIAs). Income Riders are attache benefits to these policies, so I don’t consider them a stand along longevity annuity.
All of the longevity annuity types listed above can be used in Traditional IRA, Roth IRA, and non-IRA accounts. The contractual guarantees are the same regardless of the retirement account or if you use non-qualified (i.e. non-IRA) retirement savings. The only difference is the taxation of the income stream.
If you use a longevity annuity type inside of a Traditional IRA, your Required Minimum Distribution (RMD) will be covered by that annuity income stream for that specific dollar amount in the annuity.
Before buying a longevity annuity (or any type of annuity for that matter) with a specified lump sum, ask and answer these two questions.
Assuming that lifetime income is the primary goal, the product type that you choose will be determined by your answers. Remember that the contractual guarantees are the same regardless of the account type that you use. The only difference will be the taxation of the income stream.
If it’s a Traditional IRA, then all of the income will be taxable at ordinary income rates. If it’s a Roth IRA, then none of the income will be taxable. If it’s a non-qualified (i.e. non-IRA) account, then only the interest portion of the income stream will be taxable.
If you need income to start within a year, then a Single Premium Immediate Annuity (SPIA) is the choice. If you want income to start in a few years or more, then a Deferred Income Annuity (DIA) works with non-IRA money. DIAs also work with Traditional IRA money if you are deferring up to around age 70. Once you need income to start in your 70s, a QLAC used with Traditional IRA money works. You can also shop Income Riders for “Income Later” needs as well, and remember that all longevity annuity types work in a Roth IRA to provide tax-free income.
It’s important to find an objective longevity annuity calculator that shops all carriers for the highest contractual guarantee for your specific situation. Annuity quotes are like a gallon of milk, and expire every 7 to 10 days. You can lock in a desired quote during the application process.
Just remember one thing when it comes to longevity annuities. There’s no ROI (Return on Investment) until you die. Up until that point, it is a pure transfer of risk income stream that you can never outlive...just like your Social Security payments. The more lifetime income, the better. Nod your head.