Longevity insurance is a policy that gives guaranteed income for life and this is a very hot topic. Just about everyone you know wonders if they are going to have enough money to retire or not. They may not talk about it but believe me…they’re thinking about it.
How does longevity insurance work?
It really isn’t anything new. In fact, it’s more of a twist on a very old investment that most people (including myself) dislike; annuities. However, just because annuities generally stink, it still pays to have an open mind and take a look at longevity insurance if it really can guarantee income for life.
Why the sudden interest?
Recent legislative proposals would, if passed into law, require 401k plans to allow participants to trade some or all of their entire retirement plan for these deferred annuities that would provide longevity insurance which will ultimately give the participant an immediate annuity payout. If that becomes law, millions of people are going to be interested in this – including you.
What are the mechanics of this?
Simple. You buy an annuity now and you start receiving benefits when you are between the ages of 80 to 85. Typically, you’d buy the annuity around retirement age and wait to collect benefits. By doing so, you save a boat load of money. Investment News Magazine recently shared that if you wanted to generate $20,000 in retirement income for life starting today, a 65-year old would have to invest over $270,000. But if that same 65-year old agrees to only start collecting benefits at age 85, she’ll only have to plunk down $35,000 according to the Council of Economic Advisors.
Why is it so cheap?
First, by giving the insurance company your money now but only claiming benefits far into the future it allows the company to put the money to work and build up a higher value upon which to generate retirement income. Also, because the money is invested for a very long time, the company can buy longer-term investments which pay more interest.
Finally, the people who die early help create a larger pool of assets for the lucky survivors. Remember, if you buy one of these policies, the payments stop as soon as you do. If you are not living at age 80 or 85, you and your family get nothing under most policies.
Why isn’t everyone buying these policies?
First, many people want more income now. They are more concerned about the here and now as opposed to the future. Next, there is the risk factor. What happens if you die prior to claiming benefits? What happens if the insurance company goes out of business before you do?
And even if you don’t have these concerns, low current interest rates mean future income payments won’t be as high as they would if current rates were higher. Because rates are so low, you would have to put a ton of cash into these policies in order to generate a decent cash flow. People are waiting for rates to increase before buying these policies. All these issues are putting a damper on sales.
New Features That May Improve the Viability of This Product
Some companies are offering this coverage with beneficiary riders. With these riders in place your heirs would still get some benefit if you die prematurely. Each case is different and you should careful review exactly how these riders work. Some only provide for a return of the premium (or money) you invested.
Let’s look at an example to illustrate how this might work.
Assume you are 65 today and put up the $35,000 in order to guarantee $20,000 a year in income 20 years down the line. Unfortunately, you pass away at age 84 – one year before those benefits kick in. If your policy has a return of premium rider, your heirs would get back the $35,000 you invested and that’s it. While it’s certainly better than a sharp stick in the eye, it still stinks. You’ve given an interest-free loan to the insurance company for 19 years!
For the right person this could still be a smart investment despite the downsides. Also, longevity insurance is a neat way to get a huge chunk of your estate out of your taxable estate fast. That goes for any immediate annuity – as long as there is some protection for the beneficiaries like minimum payments and/or return of premium.
You are going to hear more about this kind of insurance over the years ahead. But with interest rates this low, I wouldn’t jump into this. Rather, make sure you have a good solid financial plan in place to anticipate (as well as possible) what your financial needs might be in the future. Look at your income and estate tax needs and re-evaluate often. At some point, a product like this just may work.
How do you feel about longevity insurance? Does it seem to be something that would benefit you? Why or why not?