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Should You Add Longevity Insurance to Your IRA?

Adam Zoll
Christine Benz

Adam Zoll: For Morningstar, I'm Adam Zoll and welcome to The Retirement Radar.

Here to discuss recent developments in the area of retirement planning is Morningstar's director of personal finance Christine Benz.

Christine, thanks for being with us.

Christine Benz: Adam, it's great to be here.

Zoll: There were some recent developments involving a product called a longevity annuity and what it means potentially for retirees. What can you tell us about what a longevity annuity is, and what the recent developments were?

Benz: In contrast with an immediate annuity, where the payouts start immediately as soon as you give the insurer your money, a longevity annuity means that the payments start at some later date. So, if you purchase the annuity at, say, age 65, you will get a stream of payments starting at age 85.

These types of products have been around for a while, but in the past what had been an impediment to really using them, certainly within an IRA, was the role of RMDs. If your payments don't start until you are 85, but RMDs are supposed to commence at age 70 1/2, what happens with this product?

The new regulations issued by the Treasury Department firm up the role in the usage of these longevity annuities within IRAs. As long as you stick within certain limits, so you don't put more than 25% of your total IRA portfolio in the longevity annuity contract, or it's not more than $125,000 (it has to be the lesser of those two figures), you are able to put that product within an IRA, and it is deemed to count toward your RMDs, because the supposition is that you will begin taking money out of it at some point down the line.

Zoll: In general, what are some of the attractive features of the longevity annuity product?

Benz: I think the key one is it allows a retiree to plan for a knowable time horizon. You might say, with a pretty good probability of success, my portfolio will last until I'm 85. If I turn out to live until age 95, I'm not so sure. So it allows you to guarantee yourself an income stream for those later years if you end up being someone with a much longer-than-average lifespan.

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The other thing is that, because the payments don't start right away and because the insurer can earn some interest on your money before it needs to start paying you, these products can deliver pretty good benefit in one's later years, without a big cash outlay.

Another reason I think someone might give it a look is if they are trying to lay the groundwork in case a number of different eventualities happen later in life. The products are pretty flexible. You can use the money on anything. If you're healthy and well, you can go about your lifestyle and use the proceeds from the contract to pay you some sort of income during those years. But if you end up needing long-term care or something like that, you could use the money from the contract to defray those costs.

It's a little more flexible than, say, a single-use contract like long-term care insurance. The downside of completely foregoing long-term care insurance in favor of a product like this is that, if you need long-term care at, say, age 70, and your annuity isn't going to start paying you until age 85, you're out of luck.

Zoll: Let's talk about some of the downsides of the longevity annuity. I would imagine your life expectancy, for one, is kind of an important swing factor?

Benz: It is. If you end up dying before you begin receiving any payments at all, that obviously is a big issue, and certainly that's an issue with a lot of different types of annuity contracts.

The other issue is that when you look at the rate of return on some of these products, you may in fact be better off investing in a fairly low-risk asset. You may be able to earn a better rate of return by doing that, versus sinking your money into one of these contracts.

The other issue--and this is something that is a little bit sticky--is inflation. Typically you can buy one of these products and have your benefit be inflation-adjusted. The problem is that you don't get an inflation-adjustment from the time that you buy the product to the time that it starts making payments to you. That's certainly a big consideration when looking at these products.

I've talked to our colleague David Blanchett, who heads up our Retirement Research here at Morningstar. His view is that these products are going to become a lot more prevalent. He said it's a pretty thin market at this point, but now that the floodgates are open for these products to be usable within IRAs, he expects there will be a lot more, and probably a lot more competition, meaning perhaps better rates of payout.

Zoll: And as life expectancies continue to go up, they make more sense for more people also.

Benz: Exactly. I think the takeaway would be, if you are someone who has a lot of longevity on your side, if you have a lot of folks in their 90s in your family, you would tend to be the best candidate for this type of product.

Zoll: Switching gears, there was a recent study that came out that quantified a gender gap with regard to retirement savings. What can you tell us about that?

Benz: The latest study is from TIAA-CREF, and specifically it looked at the extent to which employees take full advantage of employer-provided matching contributions in the company retirement plan. And CREF discovered that there is a little bit of a gulf in terms of males' and females' willingness or ability to take full advantage of the matching contributions.

On average about three-fourths of workers are maximizing their match, so that's good. But about 72% of women in the CREF survey were maximizing their match. For men it was 82%. That's a pretty big gulf.

It indicates that women are not taking full advantage of those retirement plan contributions, perhaps in part because we still do have a wage gap that breaks down by gender. There is a lot of contentiousness about how specifically to calculate this wage gap, but really it appears no matter how you slice it, that women over their lifetimes earn less than men.

Zoll: But the gap in retirement savings is not confined just to the employer-sponsored plans. It's also true in IRAs as well, isn't it?

Benz: That's right. So there was some recent research that came out from EBRI, the Employee Benefits Research Institute, that looked at IRA balances, back in 2012. My guess is that they've gone up a bit, since 2013 was a really good year for the market. But the EBRI research found that the typical male IRA balance was about $140,000; whereas, females have about $82,000 in their IRAs. And again this is dating back to 2012.

I think there, again, it probably does go back to the fact that males over their lifetime will, on average, tend to have higher earnings than females. That makes it easier for them to save.

Zoll: In light of these trends, are there things that women should be trying to do in order to provide for their own retirement security?

Benz: I think there are a few key things, and one that would be true of any worker, male or female: Just try to maximize your savings rate to the extent that you possibly can. If you are earning matching contributions, see if you can at least contribute enough to earn that match before spending any assets.

And another thing: A lot of women opt to stay home with their children, to help raise their children. I think it's important to consider retirement planning as part of that decision-making process. I think a lot of couples look at the numbers and think, can we make this work on a year-to-year basis in those years that you are out of the workforce. Look beyond those years into the retirement years, and see the impact of those lost contributions on couples' total retirement savings.

The other thing I would say is that non-earning spouses should make sure that at least some contributions are being made on their behalf while they're out of their workforce. So there are spousal IRAs. As long as the working spouse has enough income to cover the amount of the IRA contribution made on behalf of the non-earning spouse, you can go ahead and do that spousal IRA.

Those are a couple of the key levers that I think women should be thinking about, especially in light of the fact that women's average lifespans are longer than men's, and they tend to have higher health-care costs because of those longer lifespans.

Zoll: Lots of great food for thought. Thank you for sharing your thoughts on recent retirement trends.

Benz: Thank you, Adam.

Zoll: For Morningstar, I'm Adam Zoll. Thanks for watching.