How Longevity Insurance Can Keep You From Outliving Your Money

You want a long and happy life. But what if that life goes on too long? Have you considered the possibility that you haven't stashed enough savings away to support yourself if you live to be 90, or even 100?

Longevity insurance might help ease your worries. But this product, also known as an advanced life-deferred annuity, does come with risk: You can purchase it, but, if you don't live as long as you expect, you may never benefit from it.

We're living longer

A study by the World Health Organization and Imperial College London found that by 2030, the average life expectancy for women will be 83.3 years and 79.5 for men. Currently, according to the study, the average life expectancy is 81.2 years for women and 76.5 for men. As people continue to live longer, it's only logical that they'll need more money to support themselves during those years. If you retire at age 67 and live to be 87, you'll need enough money to live for 20 years in retirement. But what if you live to be 100? That's 33 years spent without a regular paycheck. And that's where longevity insurance comes in. (See also: Is Long Term Care Insurance Worth It?)

Longevity insurance basics

Longevity insurance is designed to help retirees cover their expenses if they happen to live for a very long time. The product provides policyholders guaranteed income for life once they reach a certain age, usually 80 or 85. It's designed to provide extra income to supplement retirement savings that might be dwindling.

Of course, this protection doesn't come free. You'll have to pay a lump sum to open a policy, something you'll usually do right before you hit retirement age. How much the policy pays out once you hit the trigger age depends on how much you pay for your policy and how old you are at the time you purchase it.

MetLife provides a good example of how this works. According to a brochure advertising the company's Longevity Income Guarantee annuity, a man who makes a lump-sum payment of $50,000 at age 55 would receive an annual payout of $17,334 beginning when he turns 80. That same man would receive an annual payout of $30,619 if he waited until 85 to begin receiving his monthly payments.

A man who invests $50,000 at age 60 will receive $8,017 a year if he elects to start receiving payouts at age 75, and $21,741 a year if he instead waits until he turns 85.

The payouts for women are a bit lower, since women have longer life expectancies. In the example above, a woman who invests $50,000 at age 60 will receive annual payouts of $20,515 if she decides to start taking payments at the age of 85.

The drawbacks

While longevity insurance can provide you with additional protection throughout your retirement, it does come with some drawbacks. First, there's the price. In the MetLife examples, for instance, consumers are investing $50,000 into the product. That's a lot of money. And depending on where that money comes from, it could make a serious dent in what you are saving for retirement.

That's why the best candidate for longevity insurance is someone who not only expects to live a long life, but someone who can comfortably afford to part with that large lump-sum payment. You shouldn't spend more than 10 to 20 percent of your nest egg on a longevity insurance payment.

There's also inflation. Coverage that you purchase today won't be worth the same amount in, say, 20 years. Some longevity insurance programs offer inflation protection, adding the expected costs of inflation to your future payouts. Investing in inflation protection can be a smart move, but it won't be free. You'll have to pay extra.

Then there's an even bigger problem: How do you really predict how long you'll live? Say you elect to start receiving longevity insurance payments at age 85. What if you die at age 80? With basic policies, you'll lose that lump sum you invested 20 or 30 years ago. That's because basic longevity insurance products don't include a death benefit. The money you invested will be lost if you die before your payouts begin.

Some insurers offer the option of a death benefit so that your heirs can collect at least a portion of your payout if you die too early. Again, though, you'll have to pay extra for this flexibility. And your annual payout might also be lower as a way for insurers to recoup some of the extra risk they take on by providing you with a death benefit.

One last drawback is the lack of flexibility. If you plan to collect payments at age 85, but find you really need the money starting at age 82, you may be out of luck. Some insurers do offer an option allowing policyholders to access their money early, but these policies cost more and typically provide a lower annual payout.

Should you invest in longevity insurance? It depends on how much financial peace of mind is worth to you. Because this type of insurance does come with unusual risks, you'll have to determine if the fear of outliving your income is worth the chance of investing in an insurance policy that might never pay out for you.

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