Here's the greatest challenge to retirement planning: You may live a very, very long time.
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That may sound like a silly "problem" — the kind of thing that only an actuary would worry about. But, in fact, the always-improving possibility that you could see your 90s or perhaps live beyond 100 is what makes it so difficult to manage that retirement nest egg.
If you knew for a fact that you were going to die on the day you turned 80, you could really live it up for the 15 or 20 years until then. But not knowing how long you'll need your money to last requires you to conserve it cautiously.
The National Center for Health Statistics reported on Wednesday that U.S. life expectancy has reached an all-time high. A baby born in 2009 can expect to live 78.2 years, and folks who have already have made it into their 60s tend to have higher life expectancies. At 65, the average person can expect to live to be 83.
To afford life during those so-called "old-old" years, you have to live on less in your 60s and 70s. The so-called "safe withdrawal rate" — the amount of money that you can presumably withdraw from your savings every year and have it last 30 or 40 years — tends to be right around 4 percent. You can get a somewhat higher return with a lifetime annuity, but they are expensive and you have to give up a lot of money to buy an annuity that will pay you a decent monthly sum forever.
Now, there is an insurance product that addresses that issue. It's an annuity called longevity insurance and it works like this: Buy it when you're in your 60s, and it sits dormant for a couple of decades. Then it sends you a fat payment every month, guaranteed until the day you die.
For example, MetLife Inc offers a Longevity Income Guarantee policy that is priced as follows: A 65 year old man putting $100,000 in a plan today is guaranteed a monthly check of $5,777 a month, starting when he turns 85. A woman buying the same plan would be guaranteed a monthly payout of $4,631. The amount is lower because women, on average, live longer than men.
Dallas Salisbury, president of the Employee Benefit Research Institute, an industry-sponsored nonprofit, is a big believer in these policies and owns one himself. "If I'm alive at 85, it will start paying me money," said Salisbury, whose parents both lived to be 94. "I calculated how much to purchase by assuming many, many years of very, very high inflation. But because I bought it when I was only 58, I only had to allocate 10 percent of my savings to buy it."
Salisbury, 61, said that by the time he retires, the 90 percent of the savings he had left after purchasing the longevity policy should have regrown to equal 100 percent of what he had before. "And I can spend all of that money between now and when I turn 85 without having to worry about what happens later."
Not everyone is as big a fan as Salisbury. "Conceptually, they are a fantastic idea to hedge longevity," says David Hultstrom, an adviser with Financial Architects in Woodstock, Georgia. "But the pricing is not good for the client and they have massive inflation exposure."
Hultstrom ran numbers on the MetLife policy and found that the comparable internal rate of return on the $100,000 would be below 8 percent until the man turned 93 and the woman turned 97. He said the so-called "expected rate of return" — a way of measuring the benefit by the likelihood that the consumer would actually collect it — was a low 1.82 percent for the male and 2.93 percent for the female.
Here are some other considerations:
Inflation is an issue. "There is no COLA (cost of living adjustment) here, so people would need to think about that," says Julia Lennox of MetLife. Presumably, a purchaser would have to buy enough coverage to provide a meaningful monthly benefit in 20 or 30 years. That $5,777 in 20 years would have the buying power of $3,199 today if inflation averaged 3 percent a year over that period. At 4 percent inflation, it would be $2,634.
So is health. Having $3,000 a month in buying power when you're elderly is significant, but it's not enough to pay all the bills if you're old and sick and need lots of care. So a longevity policy like this will help, but should not replace a long-term care policy, or other plans to save for long-term care issues.
It's personal. The value of longevity policies varies significantly with the characteristics of the person considering it. Lennox says it works best for someone who has a "middle" amount of assets — between $250,000 and $750,000. Someone below that amount will probably not have enough money to set 10 percent or more aside for a long-term product like this. At higher levels of savings, you may be able to self-insure for a long life.
Couples may also find the idea of buying two policies challenging. It would cost them double — there's no discount for insuring two people instead of one. And they may find that investing the $200,000 instead gives them more leeway to let whichever partner dies longer have access to their funds.
Interest rates are low. The amount of money that an insurance company can safely make by investing your premium in bonds gets factored into the price of a long-term annuity like this. And right now, interest rates remain low by historical standards. Wait a few years and you might get a much better quote on the same policy. Lennox suggests that folks who want a longevity plan consider "laddering" into them. They could buy a smaller plan now, wait a few years and buy another small plan. Over 5 years or so, they could end up with a few policies priced at different (and presumably more favorable) rates.
It's new. There still aren't a lot of companies even offering longevity insurance, and some critics contend that the product still has some evolution ahead of it. "Right now we're in version 1.0," says Christopher Cordaro, a financial adviser in Morristown, New Jersey. He also thinks the idea is compelling in theory, but too expensive in practice. "You don't want to buy software until it's at least 3.0; this is the same way." he said. So watch that space.