Lowering the Risk of Outliving your Money
I have spoken with many folks who are ultimately concerned about outliving their money in retirement.
Many investors are afraid of needing to return to work later in life because they either haven’t saved enough or may become accustomed to spending beyond their means.
Most folks will have a very successful retirement by covering their living expenses through guaranteed income sources like Social Security and pension plans in addition to making reasonable, sustainable withdrawals from their retirement accounts, including 401(k)s and IRAs, for example.
Some investors fear they may not have enough saved to maintain withdrawals in retirement to continue covering their living expenses particularly on the heels of recently high inflation and a volatile stock market.
So, what can a retiree do to mitigate the risk of outliving their money?
Enter longevity annuities. Along with many other regulatory changes related to retirement, Congress recently revised rules related to retirement annuities this year.
Qualified Longevity Annuity Contracts (QLACs)
As a fiduciary, fee-only financial planner, I cringe when I hear the word “annuity,” as they have long been synonymous with high fees, illiquidity and lack of transparency.
True, annuity contracts are not for everyone. Investors who have saved an adequate nest egg for retirement, and are comfortable with the natural volatility that comes with a diversified portfolio, will likely not benefit from plopping money into an annuity.
Most investors will be better off sticking with a diversified, low-cost and tax-efficient portfolio.
However, people who deeply fear not having saved enough to cover even their essential expenses (like housing, food, utilities), might consider exploring a QLAC to create income to cover these costs in retirement. This may be especially beneficial for investors who fear the stock market.
How do longevity annuities work?
Investors of a QLAC hand over money from their retirement accounts such as their 401(k) or IRA to an insurance company around the time of retirement.
The insurance company will then agree to pay a set annual amount for life, beginning a decade or more into the future.
For example, a 70-year-old retiree could purchase a $200,000 QLAC and start income payments of $32,885 per year (or $2,740 per month), beginning at age 80. Based on a life expectancy to 90 years, this retiree would earn a total lifetime payout of $328,850, according to Fidelity.
Payout example of $200,000 longevity annuity for a 70-year-old investor.
What if I die prematurely?
If you buy a QLAC and pass away soon into retirement, you might out of luck. In its simplest form, a longevity annuity will stop payments as soon as you die (single-life annuity) or as soon as you and your spouse both die (joint-life annuity).
The insurance company keeps any money left over in these scenarios.
Many contracts have a death-benefit provision that pays out the purchase price minus any payments already made to beneficiaries.
Adding this death benefit lowers the monthly payments by several thousand dollars, but it provides assurance that you’ll get back (or rather your heirs will receive) the full purchase price of the annuity minus the payments already made.
Are there tax benefits?
Payments from QLACs count as taxable income just like withdrawals from your 401(k) plan and IRAs.
That said, because money directed to the annuity is no longer held in a retirement account, retirees do not need to take as much in Required Minimum Distributions (RMDs) beginning at age 73, since your total tax-deferred retirement balance will be smaller.
In this way, they are considered a tax-deferred vehicle, since you can plop money into a longevity annuity and wait to pay taxes on income generated down the road.
The good, bad and ugly:
The Pros:
Create guaranteed income in retirement (backed by insurance company)
Hedge against market risk
Reduce RMDs
The Cons:
Lower return potential, since amount invested is not tied to market appreciation
Illiquidity, since you cannot access the amount invested which is owned by the insurance company
Total payouts depend on longevity
QLACs May not be in the best interest of most retirees.
Sure, the allure of avoiding market risk by pushing it onto the insurance company is attractive, but the reality is, the insurance company will likely earn much more money by investing your hard-earned retirement dollars and later paying you out a portion of it each year.
Remember, these payment schedules are set by actuaries at insurance companies. These companies are ominously accurate in calculating when you might pass away and the cost-benefit analysis of offering these annuities.
When it comes to retirement planning, sometimes the easiest, most obvious solution is the best one: save aggressively, live within your means, and stay invested in a diversified, low-cost investment portfolio.
In case you’re interested in reading further, the Wall Street Journal published an informative article on longevity annuities.
Do you have concerns about outliving your money in retirement? Reach out to me at Ben@coveplanning.com or schedule a free consultation call.
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Ben Smith is a fee-only financial advisor and CERTIFIED FINANCIAL PLANNER™ (CFP®) Professional with offices in Milwaukee, WI, Evanston, IL and Minneapolis, MN, serving clients virtually across the country. Cove Financial Planning provides comprehensive financial planning and investment management services to individuals and families, regardless of location, with a focus on Socially Responsible Investing (SRI).
Ben acts as a fiduciary for his clients. He does not sell financial products or take commissions. Simply put, he sits on your side of the table and always works in your best interest. Learn more how we can help you Do Well While Doing Good!
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Ben Smith, and all rights are reserved. Read the full Disclaimer.