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New! Longevity Insurance for IRAs

Under today's rules, longevity insurance cannot be purchased inside a traditional IRA, but that is set to change soon.

Natalie Choate, 03/09/2012

Natalie Choate will be speaking at a location near you if you live in Las Vegas (4/26/12); Chicago (5/1/12 and 5/10/12); Overland Park, Kan. (5/3/12); Spokane, Wash. (5/8/12); Waltham, Mass. (6/1/12); St. Paul, Minn. (6/4/12); Indianapolis (6/8/12), South Bend (9/20/12), or Evansville (11/16/12), Ind.; San Diego (10/18/12); Atlanta (10/19/12); Iselin, N.J. (10/24/12); or Orlando, Fla. (Jan. 2013). See all of Natalie's upcoming speaking events.

Question: My IRA will provide a comfortable income for me in retirement if I live to the average life expectancy of the mid-80s. However, I'm concerned that I might live "too long." If I live into my 90s or beyond (my aunt just died at age 102), I will run out of money. I'm looking at two options for dealing with this problem.

One is to assume I will live as long as my aunt did, cut way back on my annual spending, and thus be assured my money will last to age 102. The problem with that approach is, if I then don't live that long I will have reduced my standard of living for no reason. (I am not interested in leaving an estate for my heirs.)

The other option I'm looking at is "longevity insurance": Using a portion of my money now to buy an annuity (stream of income) that will not start paying me until I'm in my mid-80s. With that type of annuity, I'm protected if I live "too long." Even though that costs me some money up front, and that money is "wasted" (I get zero return) if I die in my mid-80s, the cost is acceptable. Because the risk is spread out over the whole population of individuals who buy these contracts, the amount I have to spend for the protection costs less than the amount by which I would have to reduce my spending if I were to finance the entire risk of my living too long by myself.

Can I buy this type of insurance inside my IRA?

Answer: You can't now--but you will be able to soon.

Here's why you cannot buy longevity insurance inside your traditional IRA right now. As explained in my February 2011 MorningstarAdvisor column, the IRS has two sets of minimum distribution rules, one for "defined contribution plans" and the other for "defined benefit pension plans." Normally IRAs are subject to the defined contribution rules. Under those familiar rules, the minimum required distribution each year (beginning the year you reach age 70 1/2) is determined by dividing the prior year-end account balance by a "divisor" from the Uniform Lifetime Table based on your age.

But when all or a portion of an IRA is used to purchase an annuity, the IRA (or the portion so "annuitized") switches out of those familiar rules and becomes subject to the defined benefit rules instead.

Natalie Choate practices law in Boston, specializing in estate planning for retirement benefits. Her book, Life and Death Planning for Retirement Benefits, is fast becoming the leading resource for professionals in this field.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

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