Worried About Outliving Your Savings? Longevity Annuities May Help

Shop carefully: They're complex and not for every retiree

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Kim Langford June 29, 2020

This article appears at the following website: aarp.org

One of the biggest risks in retirement is outliving your savings. You can save carefully through the years, but there's a big unknown when you start to withdraw the money: You don't know how long your savings need to last because you don't know how long you'll live.

An income annuity can guarantee that you'll receive a check every month for the rest of your life. It can help supplement other sources of guaranteed income, such as Social Security, and can be especially valuable if you don't have a pension. Annuities also help to protect you against stock market turmoil. Your payouts will continue no matter what happens in the stock market or how long you live.

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Most experts recommend that you have enough guaranteed income to cover your necessary expenses such as housing, transportation, food, etc. If that amount comes to more than your Social Security benefits and any money that you might receive from a traditional pension, buying an annuity that covers the difference can be a good idea. However, you'll also need savings for emergencies, other unexpected expenses and life's pleasures. Those costs can be covered by the rest of your savings. If you follow this strategy, an immediate annuity that starts paying lifetime income right away could be a solution.

However, immediate annuities can be complex and expensive. The cost of the guaranteed income can seem high. For example, if a 65-year-old man invested $100,000 in an immediate annuity, he could receive $494 per month ($5,928 per year) for life. Monthly payouts are lower for women because they have a longer life expectancy — a 65-year-old woman could receive $469 per month. (Note: All of the estimated income in this article reflect the cost at the time of its writing and are illustrations only.) The amount of income you'll get from an immediate annuity will vary depending on economic conditions at the time you make a purchase, which payout options the annuity has and which company issued the policy. It pays to shop around for the best payout. Annuities can also be inflexible, and the decision to buy an immediate annuity is generally irrevocable. If the individual in the example's circumstances changed, he couldn't change his mind and get his money back after he invested in the income annuity.

Longevity annuities

An alternative to buying an immediate annuity is to depend on a combination of Social Security, pension benefits (if you have them) and your savings for retirement income. But this is where longevity risk comes in. If you depend on your savings to supplement Social Security, you're much more likely to run out of money in your 80s than you are in your 60s.

Another type of income annuity can help reduce this risk. It's easier to calculate how much you can afford to spend in the early years of retirement when you know you'll receive lifetime income later on. A deferred-income annuity, also called longevity insurance, provides lifetime income starting several years in the future, such as in your 70s or 80s. You can decide when the income starts when you buy the policy, but, in general, the farther into the future the payments start, the more you will get each month. For example, a 65-year-old man who invests $100,000 in a deferred-income annuity could receive $1,673 per month starting at age 80 ($20,076 per year), says Ariel Stern, chief operating officer of ImmediateAnnuities.com. Payouts are lower for women because they tend to live longer — a 65-year-old woman would get about $1,466 per month ($17,592 per year).

Many academics like longevity insurance because it's an efficient way to provide the highest guaranteed income payouts for the people who live the longest. The monthly payouts for deferred-income annuities are much higher than they are for immediate annuities, and you'll come out further ahead the longer you live beyond average life expectancy. In addition to eliminating the fear of running out of money, a deferred-income annuity also gives a firm time limit on how long you'll need to depend on your savings. If you retired at 65 and have a joint-life annuity that starts to pay at age 80, you know that you'll need to make your savings last only 15 years, regardless of how long you or your spouse live.

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However, the higher income comes with costs and risks. You'll receive the largest monthly payouts with a life-only version, which covers only one person. This type of contract stops paying out when you die — no matter when that is. If it starts to pay at age 80 and you die at age 81, you'll get only one year's worth of payments for your purchase price. And if you die before the payouts start, say at age 79, you won't receive anything at all. And, of course, there is the risk that your savings may not last long enough to maintain your lifestyle until the annuity starts to pay.

Most married couples might choose a joint-life version, which has substantially lower monthly payouts but continues to pay out for as long as either spouse lives. For example, a 65-year-old couple who invest $100,000 in a deferred-income annuity could receive $1,074 per month ($12,888 per year) as long as either of them lives.

Another option is a cash refund version, which has lower monthly payouts but promises that either the purchaser or their heirs will receive at least as much as they originally invested. The 65-year-old man who invested $100,000 would receive $1,328 per month ($15,936 a year) from the cash refund version, compared to $1,673 ($20,076 a year) for the life-only version. If he didn't live long enough to receive at least $100,000 in payments, however, his heirs would receive the difference. A joint-life version with cash refund is also available that would pay even less in monthly payments, but cover both spouses and pay the difference if both died before they received benefits equal to the purchase price.

Finally, there is the question of inflation and its effect on the purchasing power of your eventual payment. Even today's low inflation rate can reduce the value of your monthly payment over the 15 to 20 years between the time you purchase a longevity annuity and the time it starts to pay benefits.

How to choose the annuity company

If you're interested in a deferred-income annuity, it helps to shop around. The payouts can vary a lot by company for the same person. For example, the 65-year-old man who invests $100,000 in a life-only annuity could get from $1,512 per month ($18,144 annually) to $1,673 per month ($20,076 per year) starting at age 80, depending on the company, says Stern. “Some insurance companies are looking to raise more money at different times, so they may be more aggressive, or they may have made good investments and feel they can offer a higher rate of return,” he says. You can compare payouts at ImmediateAnnuities.com, discount brokerage Charles Schwab's immediate-annuity marketplace, or use AARP's Annuity Marketplace, powered by BluePrint Income.

Also look at the company's financial-strength rating because payouts can continue for several decades. Most of the companies with the current highest deferred-income annuity payouts are rated A or better by AM Best, but that may change. Spending time doing research on the company before you buy is essential.

Do you even need an annuity?

An income annuity can provide guaranteed payouts for life, but you may already have enough lifetime income to cover your needs. To figure out whether you should consider an income annuity, add up your regular expenses in retirement (such as your housing, food, transportation, insurance, and health care costs) and subtract any guaranteed sources of income you already have, such as Social Security and a pension. If you have a gap between your income and expenses, you could either cover it with your own savings or get an annuity.

The income annuity may provide larger guaranteed monthly payouts than you could comfortably withdraw from other investments. But you give up flexibility in return for those high payments: You can receive the money as an income stream only after you hand it over to the insurance company; you can't cash in an income annuity or withdraw more money than your monthly payments if your needs change.

If you get an income annuity, it's important to have other savings available for emergencies and additional expenses, or to leave to your heirs. You also need to ask yourself some difficult questions about your life expectancy — income annuities will pay out the most the longer you live. If you have health issues and a shorter life expectancy, and if you need to have more money on hand for medical expenses, then an income annuity may not be right for you.

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