When it comes down to retirement planning, there are two horrible things that can happen to you:
The worst thing that can happen to you is dying young. So you had saved money all your life to never enjoy it.
Then, what is the second worst thing that can happen to you? I’d say dying very old and outliving your money!
What could be worse than being healthy at the age of 85 but also incredibly poor at the same time? If you are concerned about outliving your money, the Life Insurance Companies thought about you and created a new product; the Longevity Annuity.
Getting Paid When You Get Older
The idea of a longevity annuity is pretty simple. While we usually buy annuities to receive a steady stream of income while we retire, longevity annuities are built to cover “the years you have less chances of living”. This is why most of them start paying an income after the age of 75.
At the age of 60, you may want to secure a part of your nest egg. Stock markets are volatile and bond fund values vary greatly upon interest rate changes in direction. The problem with annuities is usually their pretty low rate of return. A Life Insurance Company will certainly not be dumb enough to sign a contract paying you a healthy 6% return each year for the rest of your life if you are 60. Imagine what kind of internal rates of return it would have to generate to pay you 6% for the next 30 years? Most insurance companies would go bankrupt before you die!
Longevity Annuities Offering 6% Rates and More!
This where it could be interesting for investors thinking they can dance with Death for a while. Since longevity annuities start their payments when you grow very old, their rate of return for the investor are higher.
This is a simply statistical calculation: the older you get, the lower is your life expectancy. Therefore, the risk of paying you 9% per year on an investment of $100,000 at the age of 75 shows a “calculated” risk for the Life Insurance Company. If you pass away at the age of 85, the company would have paid you $90,000 and kept the remaining capital (plus potential profit) in their pocket. That’s pretty good, huh? But if you beat the estimates and you live until the age of 95, you will have received the amount of $180,000 from your initial investment. This is where the annuity rate of return becomes interesting.
The thing is that not everybody will live until the age of 95. Therefore, out of a group of 100 investors, the insurance company will make money from most of them and will probably lose money for the very few who exceed their life expectancy.
Are Longevity Annuities Good, Bad or Pure Evil?
Most people like to take a clear and hard stand on annuities. They either like them (as is the case with most life insurance agents!) or despise them. The truth likely lies in between; it all depends on your personal situation and your tolerance towards risk.
For someone who has nightmares and wakes up in the middle of the night thinking about how bad his investments are doing, there is no cost for security. Therefore, even if it means paying a high price for guaranteed monthly payment, he/she is willing to go for the peace of mind.
Others may think of their parents and grand-parents that passed 90 and still go jogging in the morning. These folks may see longevity annuities as a fair investment! After all, the annuity payment is calculated based on life expectancy stats table. If you can beat the odds, the house will pay your prize.
But this is not the case for a majority of investors. Most of us may be better served with our current investment portfolio. Equity returns will always be mathematically better than annuities’.
Another solution would be to keep a good part of your portfolio invested as is and use only a portion to buy an annuity. Therefore, you could benefit from a basic guaranteed income and improve your lifestyle from your investment returns!
This guest post has been written by Mike, a passionate investor and personal finance enthusiast. He writes about complex financial topics to make them easy to understand. He is the author of Annuity Rates HQ.