Is there a downside to living a long life? Yes – the fear of running out of money. As a financial advisor, when I develop long term plans for clients, I need to make assumptions about how long their resources will need to last. I rely on assumptions derived from a family history I talk through with a client and longevity tables constructed by insurance company actuaries. These calculations, however, only tell us what is likely to happen ‘on average’. There is always the possibility of something unlikely happening (known as a “black swan”), such as the grandmother of a friend who lived to 104.
If you think you may be a black swan, then you may want to explore longevity insurance. The term refers to a strategy or product that provides income later in life, insuring that you do not outlive your financial resources. Longevity insurance products are typically annuities that provide income only after a certain age, usually 85. In exchange for a single, upfront premium payment, the annuity provides income if the policy holder reaches 85, and then continues to make payments until they pass away.
While longevity insurance helps mitigate the financial risk of being a black swan, it comes with some disadvantages. First, many policies do not include a death benefit. That makes them a ‘use-it-or-lose-it’ proposition. Second, once the annuity is purchased, the policy holder has no access to the funds. Moreover, since inflation is one of the main issues in long term planning, inflation protection should be included in the policy, but rarely is. As the market for longevity insurance grows and matures, more companies are likely to offer policies with a death benefit and other features.
There is an important form of longevity insurance offered by the US government: deferring your Social Security benefits.
Example: A retiree at their full retirement age of 66.5 years in 2017 receives $2,900 a month in Social Security benefit. But if they waited until age 70, they would get $3,760 in monthly benefits (adjusted for inflation) for the rest of their lives. The additional $860/month benefit is their longevity insurance payout. What are they paying for it? The $121,800 in foregone Social Security benefits between age 66.5 and 70. This may be a good deal if they expect to live past age 85.
More generally, your Social Security benefits increase approximately 8% each year they are deferred. By giving up benefits for 3 to 4 years, the retiree gets a higher benefit once they start taking Social Security. For someone deferring until age 70, it takes about 12 years to make up the benefits they gave up, not taking account of the time value of money. This means that a retiree would have to live to 82 to break even. If a retiree believes that she will live past age 82, then the 30% increase in deferred benefits acts as a form of longevity insurance.
DISCLAIMER: This information is not intended to provide legal or accounting advice, or to address specific situations. Please consult with your legal or tax advisor to supplement and verify what you learn here. This is presented for informational or educational purposes only and does not constitute a recommendation to buy/sell any security investment or other product, nor is this an offer or a solicitation of an offer to buy/sell any security investment or other product. Any opinion or estimate constitutes that of the writer only, and is subject to change without notice. The above may contain information obtained from sources believed to be reliable. No guarantees are made about the accuracy or completeness of information provided. Past performance is no guarantee of future results.