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One of the hardest parts of managing a retirement is the uncertainty of life; the mystery of betting how long a client will live and draw from his savings. An investor doesn?t want to deplete assets while alive, but setting aside too much for too many years could mean the retiree unnecessarily scrimps for a future that never happens.
The typical approach is to invest in a diversified portfolio, spend conservatively and make adjustments as necessary. But an alternative is to actually buy longevity insurance in the form of a lifetime annuity. This could be done by purchasing a single premium immediate annuity at retirement. In practice, retirees rarely want to lock up so much of their capital. Retirees use annuities so rarely that economists have dubbed their choice the annuity puzzle.
One option: A longevity annuity. This form of single premium deferred annuity still provides payments for life, but with payouts from the longevity annuity company not beginning until the distant future (for example, at age 85).
The upshot is that the longevity annuity significantly reduces how much capital must be committed to securing the longevity insurance guarantee; even as the deferred starting date can delay required minimum distributions obligations (RMD) if purchased as a qualified longevity annuity contract (QLAC) inside of a retirement account.
Despite today?s low interest rates, a current longevity annuity can be an appealing alternative to the expected returns of a fixed-income portfolio. In fact, if longevity insurance rates rise just a bit more, they may become competitive with long-term equity returns, thanks to the benefit of mortality credits. That means that eventually an allocation to a longevity annuity bucket may become standard in retirement income planning -- as long as life expectancies don?t grow so much that the longevity annuity rates drop.
UNKNOWN HORIZON
Clients who will live in retirement for just 10 years can spend far more than those who may be retired for 30 years or more. The latter client may need a larger allocation to growth investments to keep up with the pernicious impact of inflation compounded for decades. Yet without knowing the time horizon, it?s impossible to know whether spending should be higher or lower, and whether the portfolio can be more conservatively invested or...