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American life expectancy is increasing – and that increases the financial risk for retirees who need to keep their nest egg longer.
The average 65-year-old will live an additional 20 years today, about six years more than in 1950, according to the Centers for Disease Control and Prevention.
Seniors can take steps to reduce this "longevity risk" such as working longer hours and postponing social security.
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You also have some type of pension available – a longevity pension – which pension experts say is one of the best financial deals for seniors who are worried their money will run out. However, they have been little used so far.
"It depends on living long," said Wade Pfau, professor of retirement income at the American College of Financial Services. "If you live long this is how you get the best bang for your buck."
How they work
A longevity pension is like a form of old-age insurance. There are many different types, but such pensions are a form of "deferred pension".
Here's the basic premise: A retiree today gives some of his money to an insurance company and receives monthly payments many years later, usually between the ages of 75 and 85.
As with other pensions, this stream of income is guaranteed to last for the rest of your life.
However, deferred payments have a unique benefit: insurers pay more each month than other pensions that start earlier in life. (This is pathologically because shoppers are more likely to die before their income begins – thus dividing the pot of money among fewer people left.)
The idea is to create a finite horizon for planning.
Head of Retirement Research at PGIM
Here's a rough example of a quote for a 65-year-old man in New York who purchases a simple annuity with a lump sum of $ 100,000. That person would receive approximately $ 500 per month ($ 6,000 per year) for life if they received an instant payout; the same buyer would get roughly $ 2,800 per month ($ 33,600 per year) if they waited 20 years to start making payments.
These income levels can help alleviate concerns about the survival of their investments and other savings, according to pension experts.
"You don't know how long you'll live," said David Blanchett, director of fixed income research at PGIM, Prudential's investment management arm. “The idea is to create a finite horizon to plan for.
"You know if you survive this age you will take care of yourself."
One particular type – a qualified longevity annuity contract, or QLAC – can also reduce a retiree's required minimum payouts from individual retirement accounts and 401 (k) plans.
Consumers can use up to $ 135,000 or 25% (whichever is lower) of their retirement savings to buy a QLAC. Someone with $ 500,000 in retirement savings would calculate a required payout at $ 365,000 instead of the full $ 500,000.
However, despite their advantages, these pensions are not popular with seniors.
According to LIMRA, a group in the insurance industry, deferred annuity accounts for $ 1.7 billion (or 0.7%) of the $ 219 billion in total annuity revenue in 2020. (Since longevity pensions are a subset of deferred pensions, their proportion would be even smaller. LIMRA does not publish this data.)
By comparison, variable annuities accounted for nearly $ 99 billion in sales last year.
The discrepancy is largely due to the psychological hurdle of handing over a large sum of money that is of no benefit unless you survive another 20 years, Blanchett said.
And they're not for everyone – a retiree who wants control and flexibility over their money can have a hard time handing cash over to an insurer. You may prefer to invest the funds instead.
"(Longevity annuities) are possibly the most efficient annuity in economic terms," said Blanchett. "You are without a doubt the toughest at behavior."
Perhaps the easiest way to incorporate a longevity annuity into your financial plan is to find a desired level of guaranteed future monthly income and use the annuity to fill in gaps after considering other sources of income like social security and retirement, Blanchett said.
(For example, a retiree who imagines it will need $ 50,000 a year to live comfortably by the age of 85 and is already receiving $ 30,000 a year from Social Security would seek insurance quotes to get the lump sum determine what it takes to generate $ 20,000 per year from the annuity.)
However, this is more difficult financial planning than with other pensions – precisely because it is difficult to determine how much money you will need to live in two decades, says Tamiko Toland, director of bond markets at CANNEX, who provides pension data. This is all the more difficult when trying to estimate how inflation will affect the future cost of living.
According to experts, the creditworthiness of an insurer is also becoming much more important. A higher financial rating generally means a higher likelihood that the company will make payments in the future.
It would be wise to seek quotes from multiple insurers and maybe even accept a lower payment from a higher-rated company, Blanchett said.
Consumers can buy longevity annuities with certain features that make them more palatable – but they'll be giving up a significant amount of monthly income for those features, experts said.
For example, consumers can buy them with a refund option. If the buyer dies before the start of the income, the beneficiaries are reimbursed the premium; If the buyer dies after the income has been paid, the beneficiaries receive the premium minus any payments made.