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Should You Buy Longevity Insurance?
By JLP | July 24, 2007
First off, here’s a reading assignment:
More Dollars Later In Life (Business Week)
Extend Your Retirement Savings (SmartMoney)
Both of these articles talk about a relatively new product (actually the idea itself isn’t new but the name is) called longevity insurance. In its simplest terms longevity insurance is an annuity that begins paying income once you reach a certain age - usually 80 to 85. According to the Business Week article a 65-year old man who pays $250,000 into a longevity policy, could expect an annual income of $210,000 at age 85. Sounds pretty good doesn’t it?
There’s just a few problems with this:
1. According to this page (pdf) from Social Security Administration, the average lifespan of today’s 65-year old male is 16.1 years, which puts death at around 81 years. According to this article in Forbes, a 65-year old male has a 50% chance of living to age 85. In other words, there’s a chance that this person won’t live long enough to collect the first payment. And, according to most policies, if he dies before he reaches 85, he will lose the entire $250,000 unless he opts for a policy with a death benefit which will reduce his monthly income. If he lives to 85 but dies at 86, he will have received one year’s worth of income and lost the rest.
2. Although $210,000 sounds like a lot of money now, 20 years of inflation will reduce that $210,000 to $114,000 in purchasing power. Yes, you can purchase an inflation rider but it too will reduce your benefit.
3. Once that $250,000 is invested, it is gone for 20 years. In other words, you lose that flexibility.
4. Finally, as I understand it, the $250,000 only covers one person (I could be wrong but I couldn’t find a definitive answer either way).
Is there an alternative?
Of course there is an alternative to longevity insurance but it isn’t without its own risks. First, let’s look at some numbers:
According to my research, the average annual real return (that’s after inflation) of the S&P 500 over all the 20-year rolling periods from 1926 - 2006 was 7.27%. Let’s say you take $250,000 and invest it in the S&P 500 Index for 20 years and you get an average return of 7.27%. At the end of 20 years, your $250,000 would be worth around $1,017,433. Remember this number is adjusted for inflation. At a 5% withdrawal rate, your $1 million could give you nearly $51,000 in income (in today’s dollars). And, if you died before you reached age 85, your beneficiaries would inherit whatever balance you had in your account.
The flaws with this strategy:
1. There’s no guarantee that you are going to get the average rate of return during those 20 years.
2. The $51,000 in income is less than half the income you would receive with the longevity policy.
I think if it were me, I would rather invest in a long-term care policy than a longevity policy.
If there’s any longevity insurance experts out there, I would love to hear your thoughts.
Topics: Retirement Planning |