Annuities – Longevity Insurance Is It Worth the Costs?

There has been increased press about a new type of annuity, longevity insurance. It is designed to pay benefits starting at a later age, like age 85. Thus, if you plan for your assets to last for a normal retirement (20 years or so), the longevity benefits can kick in to pay benefits in case you live longer than expected. So, is this a good idea or not?

The idea sounds good because it reduces one of the larger risks in retirement, mortality (expected lifetime). Thus, if you can find a cheap insurance to cover an additional 10 to 20 years in retirement (from 85 to 95 or 105), it, in theory, could help reduce the money you need to save for retirement.

In a BusinessWeek article, it states that a 65 year old can invest $250,000 and expect to receive $210,000 per year at age 85. So, if you can live on $50,000, then this amount would be significantly less (maybe $60,000 to $70,000), right? Before you go out and jump on this opportunity, there are a few things to consider.

1) Inflation – Even with 3.5% inflation, the amount you need at 65 will more than double by the age 85; $50,000 at age 65 will be equivalent to $100,000 in 20 years (and more the longer you live). If you get a longevity annuity indexed for inflation, expect to pay at least double what you would pay without inflation protection.

2) Married – If you are married, the cost of a policy paying benefits as long as either one of you is alive past 85 could almost double (if not double) the price policy again. What good is a policy if it only pays a benefit if you are alive and not your spouse? Thus, a hypothetical $60,000 policy (for $50,000 of benefits) could easily be worth $200,000+ if married and indexed for inflation (note, this is very dependent on your spouse’s age and time when the policy is purchased).

Yet, the benefit of having a policy that covers benefits after age 85 is a lot cheaper than buying a $50,000 annuity that starts immediately at age 65 which can easily cost $1 million (indexed for inflation and payable as long as either spouse is alive).

The key for longevity insurance is that it is suppose to lower the amount you need to save for retirement. If you are factoring in a 30+ year retirement (age 65 to age 95+), you will need to save $1 million or more to receive ($50,000 a year). Yet, to save for a 20 year retirement (age 65 to 85), the amount is reduced.

20-year annuity (6% investment return and 3% inflation) = 15.2 times the amount you need (e.g. $760,000 for $50,000)

30-year annuity (6% investment return and 3% inflation) = 20.1 times the amount you need (e.g. $1,000,000 for $50,000)

You will need to save an additional $240,000 by age 65 for the additional 10 years of retirement and more if you live past 95 where the longevity insurance can guarantee this for life. The key is if it is worth the price and that depends on how much the insurance policy will cost (remember the $60,000 policy may be $200,000 or more once inflation and marital status is reflected).

So, maybe the price of the policy is not as good as we once thought. It is still good if you live past age 95, yet not so good if you die before age 85 and thus receive nothing. Yet, the difference between a

Yet, before you make a decision, there are a few other things to consider:

1) Expense Load – With all insurance, there is a commission paid to the agent who sells the policy and to the insurance company for profit and administrative expenses. Be cautious of expenses called longevity benefit expenses. In one prospectus, there was a 1% charge of the premium each year until the longevity benefits commenced. Thus, if you buy the policy at age 55 and start the benefit at age 85, 30% of the premium could go towards paying this expense, in additiona to the standard mortality and administrative expense (which was an additional 1.35% per the policy that I saw). So, it seems there is an expense for the “benefit” of delaying the start of the annuity which can wipe out part if not all of the benefit of a longevity insurance policy.

2) Death benefit – Some policies come with a rider where you can get your initial investment back, called a cash refund. However, in getting the rider, you are reducing your monthly benefit to pay for this death benefit. I never like these cash refund because the $200,000 you invest now is worth a lot more than the $200,000 your heirs get back when you die in the future. So, is it worth it? If giving money to your heirs is important you should reconsider your financial plan because this cash refund rider is an ineffective way to provide an inheritance because too much of it goes to the insurance company.

3) Expenses later in life – Some people say a lower cost option is to buy an annuity for the fixed living expenses (needs) and use savings for your wants (travel, eating out, etc.). Thus, you would not need to buy insurance for all your expenses, just the necessities (to reduce costs). However, as you age, your fixed expenses grow (e.g., prescription drugs and home health care costs) while other expenses decline (e.g., vacations). Thus, what fixed expenses do you cover, the expenses you have now or the expenses you may have later? You may find that most of your expenses later in life are fixed.

In addition, if you have long-term care insurance, longevity insurance may add some overlap that you end up paying twice. Do you really need an annuity payment if you are in a nursing home that is covered for? It is not like you are going on vacations or eating out, if you can not even feed yourself or go to the bathroom without assistance that the long-term care facility is providing.

I bring this all up to put some questions in people’s mind before rushing out to buy a longevity policy. At first, I thought this was a brilliant idea, which it may still be under certain situations that you should review with an independent financial adviser (one not selling you the policy). However, I started to have second thoughts about the cost of the insurance when I saw a policy illustration showing the benefits of longevity insurance. In the example, a $100,000 policy to a 40 year old showed a $4,960 benefit at age 85 that would accumulate to $892,800 if the policy holder lives to age 100. However, $100,000 invested at 6% from age 40 to age 85, would grow to $1,375,000 at age 85, which can covers 23 years of a $4,960 monthly benefit even if it is not invested after age 85. Where did the extra $½ million go ($1,375,000 – $892,800)? Note, the insurance policy may have other aspects to it that the illustration is not reflecting (e.g., having the ability to invest in more aggressive assets which could increase the monthly annuity significantly, dependent on market performance).

Before considering or not considering a longevity insurance policy, please do your own review (or have an independent financial planner perform one). This analysis is based on information posted on the web provided by a major insurance carrier which can change over time as more competition hopefully reduces some of the expenses that are now being charged. The purpose of this article is to raise questions you may want to consider and should not be construed that all longevity policies are similar to the one I used for parts of this analysis.

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