American life expectancy is trending up — and that creates more financial risk for retirees, who must make their nest eggs last a longer time.
An average 65-year-old today will live another 20 years, about six years more than in 1950, according to the Centers for Disease Control and Prevention.
Seniors can take measures to reduce this “longevity risk,” such as working longer and delaying Social Security.
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They also have a type of annuity at their disposal — a longevity annuity — that is among the best financial deals for seniors who worry their money won’t last, according to retirement experts. However, they’ve been little used to date.
“It’s contingent on living a long time,” said Wade Pfau, a professor of retirement income at The American College of Financial Services. “If you live a long time, you’ll get the most bang for your buck that way.”
How they work
A longevity annuity is like a form of old-age insurance. There are many different types, but such annuities are a form of “deferred income annuity.”
Here’s the basic premise: A retiree hands over a chunk of money to an insurance company today and begins getting monthly payments many years later, generally starting between age 75 and 85.
As with other annuities, that stream of income is guaranteed to last for the rest of your life.
But the deferred payments offer a unique benefit: Insurers pay more on a monthly basis than with other annuities that start earlier in life. (Morbidly, this is because there’s a greater chance that buyers will die before their income starts — thereby spreading the pot of money over fewer remaining people.)
Here’s a rough example, using a quote for a 65-year-old man in New York who buys a no-frills annuity with a $100,000 lump sum. This person would get about $500 a month ($6,000 a year) for life if he started receiving an immediate payout; the same buyer would get about $2,800 a month ($33,600 a year) by waiting 20 years to start payments.
That level of income can help defray concerns of outliving one’s investments and other savings, according to retirement experts.
“You don’t know how long you’re going to live,” said David Blanchett, head of retirement research at PGIM, Prudential’s investment management arm. “The idea is to create a more finite horizon to plan for.
“You know when you survive to that age, you’ll be taken care of.”
A certain type — a qualified longevity annuity contract, or QLAC — can also reduce a retiree’s required minimum distributions from individual retirement accounts and 401(k) plans.
Consumers can use up to $135,000 or 25% (whichever is less) of their retirement funds to buy a QLAC. Someone with $500,000 of retirement savings would calculate a required distribution on $365,000 instead of the full $500,000.
However, despite their benefits, these annuities aren’t popular among seniors.
Deferred income annuities accounted for $1.7 billion (or 0.7%) of the $219 billion in total annuity sales in 2020, according to LIMRA, an insurance industry group. (Since longevity annuities are a subset of deferred income annuities, their share would be even smaller. LIMRA doesn’t break out this data.)
By comparison, variable annuities accounted for almost $99 billion of sales last year.
The mismatch is largely due to the psychological hurdle of handing over a large sum of money that won’t yield a benefit if one doesn’t survive another 20 or so years, Blanchett said.
And they’re not for everyone — a retiree who wants to retain control and flexibility over their money may be hard-pressed to hand cash to an insurer. They may prefer investing the funds instead.
“[Longevity annuities] are potentially the most efficient annuity, economically speaking,” Blanchett said. “They’re without a doubt the hardest behaviorally.”
Perhaps the easiest way to integrate a longevity annuity into your financial plan is by assessing a desired level of guaranteed future monthly income and using the annuity to plug any gaps, after accounting for other income sources like Social Security and pensions, Blanchett said.
(For instance, a retiree who envisions needing $50,000 a year to live comfortably at age 85 and already gets $30,000 a year from Social Security would get insurance quotes to determine the lump sum needed to generate $20,000 a year from the annuity.)
However, this is a tougher financial-planning proposition than with other annuities — precisely because it’s difficult to determine how much money one will need to live in two decades, according to Tamiko Toland, director of retirement markets for CANNEX, which provides annuity data. That’s all the more difficult when trying to assess how inflation will affect the future cost of living.
An insurer’s credit rating also becomes much more important, experts said. A stronger financial rating generally means a higher likelihood the company will be around to make payments in the future.
It would be wise to get quotes from multiple insurers, and perhaps even accept a little bit of a reduced payment from a higher-rated company, Blanchett said.
Consumers can buy longevity annuities with certain features that may make them more palatable — but they’ll give up a substantial amount of monthly income for those features, experts said.
For example, consumers can purchase them with a refund option. If the buyer dies before income starts, beneficiaries get a refund of the premium; if the buyer dies after income starts, beneficiaries get the premium minus any payments made.