Planning for financial security with an annuity or longevity insurance

Monday, February 6, 2012
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Life expectancy is rising in the U.S., meaning financial planning is taking on even more importance.

For a reasonably healthy 65-year-old couple, chances are 63 percent that one of them will live until age 90 and 14 percent that one will make it to 100, according to the Society of Actuaries. They need to ensure that their money doesn't run out before then.

Longevity insurance is a relatively new term for an annuity designed to cover the latter years of retirement. It usually involves a person giving a sum of money to an insurer in his or her 60s in exchange for monthly payments that start at age 80 or 85 and continue for the rest of his or her life.

"Most people buy (an annuity) before they turn 65 to supplement Social Security (payments)," says Mike Tomlin of Senior Healthcare Benefits Services in Jackson.

Tomlin points out that an annuity allows your money to accumulate interest tax-free until you pull it out. "If you put $100,000 in at age 55 and took it out at 65, you don't pay taxes on that until you pull it out," he says, adding the money can be taken in monthly payments or in a lump sum.

Retirement experts say longevity insurance can make a lot of sense for those who have enough savings to spare a portion in exchange for future monthly income they can't outlive.

"This is something that people ought to be thinking about as they approach retirement," says Anthony Webb, research economist for the Center for Retirement Research at Boston College.

And while you can't outlive the payments -- Tomlin says that as long as you live, the annuity will pay out -- you can face the prospect of losing the money due to death. A solution to that, Tomlin says, is a life-certain option of 10 or 20 years.

"If your spouse takes (an annuity) out at 65 and dies after drawing the money for eight years, someone gets the benefit for the remaining years" under a life-certain plan, Tomlin says.

Another thing to consider is that once you've paid the money to the annuity, you can't pull it out early without consequences. Tomlin says surrender fees for early withdrawal can be as high as 14 percent.

"I tell clients to be extremely careful and not use a company with a high surrender fee," he says. "You have to understand it is a very long-term investment. You have to be willing to keep it (in the annuity) or you're going to get hurt on it."

In addition to the surrender charge, the guarantee is another thing to consider when choosing an annuity -- and that means reading the fine print. "Companies offer 4 percent to 6 percent (interest) in the first couple years, then 1 percent for the remaining years is in small print," Tomlin says. "That means you may have to keep the money in the annuity earning small interest. You have to be very careful and understand the terms of the contract."

Because it is a long-term investment, it's something to consider sooner rather than later. "An 80-year-old person shouldn't have an annuity with a 10-year surrender charge," Tomlin says.

But by defining the time period your savings have to cover -- say from age 65 to 85 -- before longevity insurance payments begin allows retirees to spend more confidently and invest more aggressively.

"If you have one of these that kicks in at 85, it becomes a much simpler problem of how to spend down one's wealth," Webb says.

The Associated Press contributed to this report.

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