From the time of the Reformation until about 1800, life expectancy in Europe averaged less than 40 years of age. By 1900, it had increased to 49. In God’s gracious providence, with the advent of modern medicine, immunizations, sanitation, water purification, and better nutrition, life expectancy in the United States has now increased significantly. Today, though life expectancy is 85.8 for a 65 year old male, and 87.8 for a 65 year old female, there is a 50% probability that one member of a 65 year old married couple will live to age 92!
That’s amazing! But it’s also frightening when we consider what it means for retirement planning. It means that our retirement savings may have to provide income that will last for 25-30 years, or more! As you can see, one of the greatest risks that we face in retirement is longevity risk – the risk of outliving our savings and other assets.
Longevity risk is avoidable if you save enough. But most of us have not saved enough. Many may already be planning to work longer, continue saving, delay Social Security until age 70, and perhaps ‘down-size’ our lifestyle in retirement to compensate for our lack of sufficient savings. So, for most of us, longevity risk is not only unavoidable, it is a significant threat to our wellbeing later in retirement.
Significant risks that are not preventable, or are too costly to bear ourselves, are usually insured. We insure our homes and cars against property and casualty risks, and we insure our lives when we have family members who are counting on our future earnings to pay the bills. But can we insure against longevity risk? Most of us have some guaranteed income for life from Social Security benefits. But what if that amount of income alone is not sufficient later in life? Can we guarantee a life-long income stream from retirement savings? Is that possible? Well, actually, it is.
The income uncertainty associated with living too long can be eliminated by purchasing an insurance product called an annuity. Annuities convert savings into a stream of income. They are purchased by transferring a lump-sum amount of money to an insurance company. In turn, the company then promises to provide the purchaser with a small guaranteed income payment for life, beginning either immediately, or deferred to some later date.
But in general, annuities are problematic. They do share, or ‘pool,’ longevity risk, but they are very complex legal agreements and are almost impossible to contractually escape. They pay notoriously high commission rates, possess high fees, low rates of return, minimal payments, surrender charges, and ‘tie-up’ savings for life. And, over time, purchasing power is reduced as level monthly payments are consumed by inflation. Though ‘riders’ can be added which remedy some of the above problems, they too are costly.
Not every type of annuity, however, suffers from all of these difficulties. In 2012, in an effort to encourage retirement plan sponsors to offer lifetime income options, the IRS began to publish regulations that created a new type of advanced-life deferred annuity known as a Qualified Longevity Annuity Contract (QLAC). A QLAC is essentially longevity insurance, and operates much like a reverse life insurance policy. Instead of paying-off if you die, it actually pays-off if you or your spouse live a long life!
And it’s substantially cheaper than a conventional annuity. As an institutional retirement plan offering, huge commissions can be avoided. And, a QLAC guaranteeing income for life after age 85 (though a reduced amount of income can be received earlier if necessary) might require only roughly 15-20% of your retirement savings at age 65, thus leaving the remaining 80%+/- under your control to be invested and paid out as monthly income for a known period of time (until age 85). This means that you might actually be able to increase your retirement income during your earlier retirement years. QLAC’s are very interesting products indeed.
A QLAC is not a panacea, nor a product for everyone. But like other retirement plan sponsors and financial planners around the country, the Investment Committee of PCA Retirement & Benefits, Inc. is taking a hard look at these annuity contracts. We hope to conclude our analysis soon and will report our findings to all PCA Retirement Plan participants in a future publication. Stay tuned!
Geneva Benefits Group serves those who serve others, providing practical support for the financial, physical, and mental wellbeing of people who work in full-time ministry.