Ask many up-and-coming retirees what their biggest fear is, and they’ll say running out of money. Just 18% of workers are very confident that they’ll have enough money for a comfortable retirement, according to the Employee Benefit Research Institute’s 2014 Retirement Confidence Survey.
The insurance industry has heard those worries loud and clear, and they’ve answered with longevity annuities. What are they? Essentially, these are simple deferred annuities that ask you to hand over a lump sum of cash to an insurance company in exchange for a guaranteed income decades down the road.
Longevity annuities aren’t new. But you’ll likely see many more of them after the New Year – from big names like New York Life, Guardian and Mass Mutual — now that a new law says they can be purchased inside of 401(k) and IRA plans so long as the account holder begins collecting on the policy by age 85, rather than age 70 ½ — the age when required minimum distributions must begin.
Here’s how this looks in practice. Let’s say you have a $500,000 IRA. Under the rules, you’re allowed to take 25% of that account or $125,000, whichever is less, and buy a longevity annuity. The amount of your paychecks will depend on when you opt to start taking the income; the longer you wait, the lower your life expectancy, so the higher your monthly checks will be. But because you put $125,000 into the annuity, instead of taking required minimum distributions on the full $500,000, they’d be based on the remaining $375,000. If you die before you start receiving income you can structure it so 100% of the value will go to your beneficiaries; even if you’ve turned on the income stream, you can set it up so that the remainder goes to beneficiaries.
“These annuities have been around for 10 years, but they’ve only really been sold for three and they only represent a little more than 2% of annuity sales. This ruling is going to educate the public on how these products work,” says Stan Haithcock, an annuities expert. Haithcock is a fan of these products for their simplicity. (Variable and index annuities don’t qualify under the new law.) “This is an easy to understand pension product. I could explain it to a 9-year-old,” he says. “My prediction is that in 5 years, they will be the number one type of annuity in the country.”
Should you take the bait? The downside to these products involves liquidity and flexibility. “You can’t change your mind and say, ‘send me all my money back,’” Haithcock says. “That’s one reason the government put a limitation on what you can put in.” You should also steer clear if you need all of the money you expect to get from RMDs to live on. “This isn’t for the person who needs more money from their IRA or needs to access a lifetime income stream sooner,” he says. “But the vast majority of [people] with traditional IRA wealth will be okay with pushing some of these assets.”
There’s also the question of whether you can create an income stream of your own that allows you to maintain more control over your assets.
“In my practice, I’m employing something along the lines of a bucket strategy, which means there are three buckets of money — a stock bucket, a bond bucket and a cash bucket. Typically, clients will have two to five years of expected withdrawals in the cash bucket, so you’re creating your own income stream and it’s no different from what the insurance companies are trying to do,” explains New York Certified Financial Planner Bill Losey. The missing element for the DIY approach: guaranteed income. You may do better than you would with an annuity. Then again, you may do worse.
Finally, if you do go down this road, Haithcock says to be wary of agents who try to change the discussion to variable or index products where they’ll get more money. They’ll try to change the conversation. Don’t let them. “This option was put on the planet for young workers to be able to put money away that is targeted to lifetime income stream,” he says. If today’s retiree fears are indicative of the future, they’ll need it.
Arielle O’Shea contributed to this report.