We recently wrote about the role annuities can play in your retirement plan. We noted that a basic, traditional annuity provides guaranteed income that you can’t outlive. Academic and industry research confirms that retirement plans are stronger and more secure with annuity income. Because annuities provide long-term financial security, many retirees find them attractive. We referenced a special type of annuity, longevity insurance, and here we’ll look at them a bit more closely.
What is longevity insurance?
This is an annuity that you purchase today, but which doesn’t begin to pay you a regular stream of income until some point in the future. So, it is a “deferred”, rather than an “immediate”, annuity. You might, for example, buy a deferred annuity at age 65 and elect to have the payments start at age 85.
Why would you buy longevity insurance?
As people get older, they tend to become more risk-averse. For example, older people generally don’t jump out of planes, indulge in recreational drugs, go on international trips to dangerous parts of the world, or invest in risky start-up companies. They want security, predictability and simplicity. Annuities are in many ways an ideal investment for retirees.
Longevity insurance addresses a few additional concerns for retirees. Over time, inflation erodes your purchasing power. It can be particularly troublesome for retirees who’ve stopped working, thus no longer receive a paycheck, and then must rely on their savings for income over the next 30+ years of their lives. With inflation, everything inevitably become more expensive.
Let’s look at an example. Assume you retire at age 65, and your electric bill is $100 per month at that point. If inflation is 3% per year (which is actually below the historical long-term average), that same bill would be $165 per month at age 80. Retirees are particularly sensitive to the impact of inflation, because they spend relatively more on things like utilities and health care, for which the prices tend to go up faster than do the prices for other consumer items, like clothing and recreation.
Expenses can go up in other ways for retirees, too. They tend to spend more on things for which they spent little, if anything, earlier in life. As you get older, you may need help with chores, both inside the home and outside in the yard, and with personal care. So, you can end up with new, additional expenses and this may impact you financially.
If you’re fortunate enough to live into your 80s, 90s or even beyond, you may run the risk of depleting your savings and investments. If your initial withdrawal rate from your investments was based on living to normal life expectancy, but you instead live 10, 20 or even 30 years longer, you can exhaust your nest egg.
Having a new source of income late in life can help you relax and maintain your desired lifestyle. Longevity insurance may be a solution.
Qualified Longevity Annuity Contract (QLAC)
OK. So, you like the idea of an additional source of predictable income, but you’d prefer to buy longevity insurance inside your Individual Retirement Account (or other qualified retirement account). Well, the IRS will allow you to do this, with some limitations. Ordinarily, the entire amount of your IRA is subject to so-called “required minimum distributions” (RMDs). This means that at age 70 ½, you must begin taking distributions from your IRA. RMDs are normally calculated on the full value of your IRA. This would be problematic with longevity insurance, because the very point of the strategy is to defer the income until later in life.
Fortunately, the IRS will allow you to place the lesser of 25% or $130,000 of your IRA into a “qualified longevity annuity contract”. You can defer the start of the annuity payments up to age 85.
If you’d like to learn more about longevity insurance, please contact us at any time. While Springwater doesn’t sell any financial products, we can refer you to an insurance specialist who can advise you. You may also wish to consult your insurance agent and/or tax advisor.
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