Live Long and Prosper? Insurance Might Help
March 11, 2015 by John F. Wasik
For those heading deep into retirement with relatively stable health, “rage against the dying of the light” often translates into a fear of outliving their nest egg.
As a relatively new product, longevity insurance addresses that concern, although it’s a complicated product full of pitfalls that need to be considered.
Longevity policies, also known as deferred-income annuities or qualified longevity annuity contracts, provide an income stream at a certain age, usually from 80 to 85. When payments begin, they are usually guaranteed for a minimum period — generally 10 to 30 years. The policies are typically bought with a lump sum decades before they are needed.
With life expectancies on the rise, the Treasury Department and the Internal Revenue Service last year approved the inclusion of longevity policies in 401(k) and I.R.A. plans. They are becoming popular. Treasury will allow people to use up to 25 percent of their balances in such accounts, or $125,000 (whichever is less), to buy a longevity annuity; it also relaxed a requirement that people take minimum distributions from their plans at age 70 1/2 because annuity payments start later in life.
Longevity insurance is still a tiny slice of the more than $230 billion market for annuities, but with more people retiring and many companies getting into the business, sales more than doubled from 2012 to 2013 to about $2 billion per year at the end of 2013. They were expected to have grown an additional 20 to 25 percent in 2014, according to Limra, a life insurance trade organization.
Part of the appeal of these policies is that they hedge a bet on life expectancy. If, like many, you underestimate how long you’re going to live — and don’t prepare for it financially — longevity insurance will provide income in your remaining years.
An American woman who reaches age 65, on average, will live to be 87. A 65-year-old man’s life expectancy is about 84, according to the Social Security Administration’s life expectancy calculator, which doesn’t consider a person’s health or family history. About one-quarter of 65-year-olds will live to be 90; 10 percent will live past 95.
Yet insurance for an extended life span can be costly. As with any life or health insurance product, you will pay more for these policies the longer you wait to buy them. And most of the longevity annuities pay nothing to beneficiaries if you die before you reach the age to receive payments. One exception is a cash refund annuity, which has a clause that says if the policy holder dies before the annuity payments received equal the annuity payments made, the insurance company will pay the difference to the beneficiary.
Here’s how they work: You pay a lump-sum premium at an earlier age, then collect predetermined monthly payments beginning at age 80 through 85. You get no inflation protection before you start collecting payments — unless you pay extra for an expensive “cost of living” rider — but you will after you begin receiving payments. The lack of inflation protection before payments start is a significant risk for most people, especially if inflation roars back before the money is needed.
For example, you may pay $50,000 for a MetLife Longevity Income Guarantee product at age 50. If you’re a man, you would receive nearly $43,000 per year at age 85 and about $39,000 annually if you’re a woman. (Women generally live longer, so payments are lower.) You would receive even more income if you bought the policy earlier (and took payments at 85): $60,000 a year for men and $53,000 for women if bought at age 45.
Keep in mind that the lump sum for your policy before you take payments is tied up in the insurance company’s investment portfolio. That’s why the company pays you more the longer you wait. You may be able to do better on investment returns on your own or with an adviser.
“I would probably not use or recommend the policies based on what I currently know about them,” says Roger Wohlner, a financial adviser in Arlington Heights, Ill. “The insurance company has your money for 25 years or so. You need to examine all of your retirement resources such as pensions and long-term care coverage and lay out the pros and cons.”
While Mr. Wohlner leans toward prudent portfolio management, what if that option leaves you skittish about having enough money? Then longevity insurance may make sense.
“You get a better price at a younger age,” says David Blanchett, head of retirement research for Morningstar Investment Management in Chicago. “It’s the most efficient way of hedging against longevity risk.”
Yet you have to weigh the trade-off of tying up your money with the fact that you (or your heirs) could lose what you invested if you die before taking payments.
Mr. Blanchett obtained quotes from a number of providers and found that having a “cash refund” feature that would pay back some of your premium to your estate reduces the amount you would be paid at age 85. He found in one instance that a man buying a $100,000 annuity at 65 would receive $54,000 with a conventional “life only” product, but only $37,000 annually with the cash refund provision.
Are these products worth the cost? The payments could be used to cover nursing home costs and supplement living expenses, so they might be worth it. But you are essentially making a bet that you will live long enough to need the money and that your portfolio will come up short.
There are other ways of addressing the cost of longevity, though. One alternative to buying private insurance is to delay filing for Social Security benefits until age 70. That will ensure the highest possible retirement payment and perhaps cover a shortfall from your retirement fund.
You can also buy long-term care insurance to cover nursing home expenses and ensure that your portfolio can cover your cash needs in later years — if you can afford the premiums.
Often retirement portfolios can be adjusted to deliver returns over longer periods, through investment selection and lower spending. An adviser could show you a number of plans based on different life expectancies, cash-flow needs and portfolio risk and return estimates.
At the very least, it might be best to project how long your nest egg will last given how much you expect it to return and expected retirement withdrawals. There are several online tools that can help you make these calculations.
Since you may have enough assets in your portfolio to see you through your ninth, 10th and possibly 11th decades, it makes sense to sit down with a qualified adviser for a portfolio review before buying a policy.