Should You Consider Old Age Insurance?

The danger of outliving our money is a very real one as our lifespans increase, and now an investment that addresses that risk can be made available in your 401k plan.

The investment is a “longevity annuity,” and it works like this: You invest a sum of money now and you start collecting income from the annuity many years in the future. An example is someone at 65 buys a longevity annuity that starts a payout at 85. So $50,000 might be invested at retirement at age 65, and in 20 years the annuity would pay $1,400 a month, or $16,800 a year.

Do that math, and that means the investor will make back his $50,000 in just three years, which sounds like a sweet deal. Then again, if the investor dies before turning 85, the insurance company gets the money. But that’s how insurance products such as annuities work – you pay for protection you may or may not need.

The reason these weren’t available in 401k plans before is they would have violated the required minimum distribution (RMD) rule, which requires payouts after age 70½. But on July 1, the Treasury Department and the Internal Revenue Service made an exception to the RMD. The new exception also applies to individual retirement accounts (IRAs).

The value of your longevity annuity contract is excluded from your 401k or IRA account balance that is used to figure the RMD distributions after age 70½.

There are limits. Retirement plan participants can use $125,000 or up to 25% of their IRA or 401k — whichever is less — to buy a longevity annuity, also called a deeply deferred income annuity. The dollar limit will be adjusted for inflation in $10,000 increments.

So, should you consider such an investment?

In principle, yes. First, you shouldn’t think of annuities as a win/lose proposition – a roll of the dice. You’re not gambling on your lifespan, you’re spending some money to insure you’ll have enough money in the future. So the concept is a good one.

But there are a lot of ifs and buts. One if: Will your employer offer such a product in your 401k? Another if: Even if it does offer one, is it a good one? While the annuity industry is offering much better products these days, you probably know that many come with low payouts and high fees. Some are outright rip-offs.

In your 401k, you’ll be limited to what your employer provides, but if you also have money in an IRA, you can have the universe of longevity annuities to choose from. You just need to transfer IRA money to the company that sells the annuity you want.

Or, if you plan to roll your 401k into an IRA at retirement, you may want to wait until that point to buy such an annuity, so you’ll have choices.

Choosing any kind of annuity isn’t easy, and such deferred annuities often come with literally dozens of pages of fine print. You’ll have to make decide if the annuity will make payouts adjusted for inflation or not (inflation adjustment is generally a good thing). And with interest rates at historic lows, so are annuity payout rates. If you have time to wait, you may want to postpone buying a deferred annuity until rates return to historical averages.

If you think buying a longevity annuity with retirement plan dollars – be they in a 401k or an IRA – might be right for you, consulting a financial planner who is an expert at annuities would be a smart idea.