Photo (cc) by aka Jens Rost
Worrying that you could outlive your money? If so, you’re not alone.
In the past it was common for employers to provide a pension plan, known as a defined benefit plan. These plans, like Social Security, provide a monthly check you can’t outlive. Today, however, more companies shift the retirement burden to employees by providing a 401(k) or other savings-type plan. These plans, known as defined contribution plans, allow the employee to save money in a tax-advantaged investment account they can draw on in retirement.
The problem? No matter how much you build up in a 401(k), you won’t have a predictable, or necessarily comfortable, income for life. That’s not a relaxing feeling for those entering into what are supposed to be relaxing years.
The insurance industry long ago recognized this problem and created a solution. It’s known as a longevity annuity — an investment you fund now that guarantees you a future income stream for life.
Sow now, reap later
Here’s how it works: With a longevity annuity, also known as a single premium deferred annuity, you pay a lump sum, then wait a period of time before collecting your stream of income for life.
The younger you are when you buy the policy, and the older you are when you collect, the lower the price. “Not everyone will live beyond 80 or 85, so those who do so can collect more income than they would have been able to produce on their own,” Reuters says.
Longevity annuities aren’t new. But they’re a hot topic now because the government recently changed the tax rules, making them more attractive and more accessible to retirement savers.
The Treasury Department and the Internal Revenue Service (IRS) just gave IRA owners and 401(k) plan participants the green light to invest in longevity annuities inside their retirement accounts, without having to worry about laws that require minimum distributions (RMDs) from those accounts after age 70½.
Why buy a longevity annuity?
The obvious answer is to have an income stream for life. The newly approved products — called “qualifying longevity annuity contracts” or QLACs — are:
- Exempt from required minimum distributions. When you invest in 401(k) plans and IRAs, the IRS requires that, after you are 70½, you have to withdraw at least a minimum amount each year. QLAC longevity insurance is exempt; you can keep your money in the account until your scheduled payouts begin.
- Priced identically for women and men. Women generally live longer than men, and so they’d typically be required to make a larger initial investment to get the same monthly lifetime benefit from an annuity — up to 25 percent more, according to USA Today. But employer plans use unisex mortality tables, so women and men will pay the same price.
- Sometimes offered with death benefits. Longevity annuities may offer an optional return-of-premium death benefit. That means if you die before receiving at least as much as you’ve put in, premiums paid but not received can be returned to your account. Choosing a death benefit, however, can reduce your monthly payments.
- Sometimes offered with inflation protection. Products vary, depending on your company and the insurer, but inflation adjustments are a feature of some — for a fee, of course. Joseph Tomlinson, managing member of Tomlinson Financial Planning LLC in Greenville, Maine, told USA Today, “The ideal would be a product that paid out in real dollars, adjusting for inflation during both the deferral period and the payout period.”
To learn all of the details, read the new Treasury Department regulations.
Costs and the payouts
Costs will vary, depending on your age and when your payout starts, and on whether you purchase features like a death benefit or inflation protection. They will also vary wildly depending on which company you choose.
According to Consumer Reports, a 65-year-old man making a $100,000 contribution can expect to receive from $36,000 to $62,000 annually upon reaching age 85, depending on the company issuing the contract. That’s a big spread and underlines the need to shop carefully.
Should you buy?
The new rules let you use up to 25 percent of your IRA or 401(k) account balance or $125,000 (whichever is less) to buy a qualified longevity annuity.
The idea is not to invest all your savings in these products. There’s safety — and perhaps better returns — in diversifying your investments. You’ll need a portion of your retirement savings accessible in case you need to make big withdrawals.
Another factor to consider: Annuity payouts are tied to interest rates. You might regret locking your money up now, when rates are at historic lows, if rates rise a few years down the road. Investing when rates are higher means a higher income when you start taking payments.
You’ll need to look at your overall financial situation to know if one of these annuities is a good fit. A smart way to do that is to hire a fee-only certified financial planner for a few hours to make sure you’re covering all your needs and seeing all the options.
Competition is coming
One attraction of these annuities is that the assurance of a guaranteed income stream later allows you to safely withdraw more from savings during your early retirement years.
One downside is that, unless you pay extra for inflation protection, the value of your payout will be diminished over time.
But there’s probably time to wait and see what the market does in response to the changes. “Expect heightened competition to improve the policies,” Reuters predicts.
Not for long-term care
If you are at retirement age now and are hoping to cover the costs of long-term care, an annuity probably is not the right tool. With the high cost of assisted-living facilities and full-time nursing care at home — the median cost of assisted living is more than $3,500 a month — you’d need to make a large investment to get a payout large enough to cover your needs. And your principal will be tied up in the annuity.
Will you have enough savings to retire? Post your thoughts in the comments are below or at Money Talks News’ Facebook page.