By purchasing the deferred annuity, you are buying the insurance only for the period for which it is needed, the mortality credits are much greater, and you greatly reduce the liquidity constraints imposed by the purchase of an immediate annuity. The later the start date, the lower the upfront payment will be. For example, one study found that for the same spending benefit, an individual purchasing an immediate annuity would have to annuitize more than 60% of his/her retirement assets versus just 11% of assets with a longevity annuity.
The same study ran additional scenarios comparing the spending benefits between men and women to highlight the difference in mortality rates by gender, and to further illustrate the higher spending benefit of longevity annuities over the purchase of immediate annuities. The results are shown here:
Partial annuitization through the use of longevity insurance not only reduces the risk that an individual will outlive their assets, but maintains the majority of assets in liquid, investable and, if possible, tax-managed accounts for flexibility and potential growth. This strategy is ideal for risk-averse investors with significant concerns about the possibility of outliving their assets.
Immediate annuities can be purchased using tax-deferred dollars because the annuities satisfy required minimum distribution (RMD) rules. In July of 2014, the Treasury department issued new regulations surrounding the purchase of deferred-income annuities in tax-deferred accounts.
The new regulations allow for the purchase of deferred-income annuities in qualified retirement accounts that begin payments after age 70.5 without violating RMD rules. However, there are certain requirements the qualified annuity must meet in order for the IRS to allow for annuitization after age 70.5:
- Only 25% of any retirement account (or 25% of all pre-tax IRAs aggregated together) can be invested into a deferred income annuity.
- The cumulative dollar amount invested in all deferred-income annuities across all retirement accounts may not exceed the lesser of $125,000 or the 25% threshold. The $125,000 amount will be indexed for inflation, adjusted in $10,000 increments.
- The limitations will apply separately for both spouses with their own retirement accounts.
- The deferred-income annuity must begin its payouts by age 85 (or earlier).
Finally, the guaranteed income generated by the longevity annuity can allow a retiree to be more tolerant of risk, thereby making it more likely that they’ll stick to a specific investment strategy during the inevitable bear markets. In addition, a retiree might feel more at ease to spend a greater portion of savings earlier in retirement, knowing that the longevity annuity payments will kick in at a later date.
Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.