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Longevity Insurance: Coming Soon to a 401k Near You?

A few years ago, the Treasury Dept. issued a ruling that may give rise to some interesting retirement planning strategies.  Owners of IRA and 401k accounts are now permitted to use as much as 25% of their account balances up to $125,000 to purchase so-called "longevity annuities".

It's likely that many of you are familiar with annuities of some type (and there are several), but you may be somewhat less familiar with longevity annuities.  So let's first take a step backward and discuss what a longevity annuity is.

Longevity annuities are also known as "deferred income annuities", "longevity income annuities", or simply "longevity insurance".  It's probably this last moniker that best describes the function of a longevity annuity. The purchaser of this type of annuity gives the issuing insurance company a lump sum now in return for a predetermined annual payout which is scheduled to begin at an advanced age (often at 80 or 85) and which continues for life, no matter how long that may be.

In this respect, this product is a rifle-shot approach to insuring against living longer than you expect, i.e. to insuring against putting unexpected strain on your retirement nest egg.  Since payouts usually begin decades after purchase and since the probability of a "claim" is relatively low, policyholders receive much more bang for the buck - in the form of a much larger stream of income per dollar invested - than with other types of annuities.

The Treasury ruling is relevant not only because it effectively allows retirees to tap additional sources of funds (their IRA and 401k accounts) to mitigate longevity risk, but also because it allows taxpayers a way to reduce the size of their required minimum distributions (RMD's) in the process.  Lump sums committed to the purchase of longevity insurance will no longer be present in retirement account balances when it comes time to calculate RMD's.  In this respect, retirees who are concerned about outliving their assets, and who also find RMD's an unnecessary tax burden or inconvenience, can kill two birds with one stone.

It's my understanding that only three insurance companies account for 90% of longevity annuity sales, so pricing of these products may not be as competitive as it could be.  And a low-interest-rate environment, as we have now, isn't necessarily the best time to commit to a fixed annuity, deferred or otherwise.  But despite that, this ruling could represent another arrow in the quiver for retirement planners.