You may not agree with how the product is used, sold or priced but you really have to respect the financial industry for being able to make a products to fit almost all situations. I recently heard about a relatively new product called a Longevity Annuity which seems to operate like an extended deferred annuity with a single premium immediate annuity twist.
What is a Longevity Annuity?
To be able to understand what a longevity annuity is you first have to under the basics of an annuity product.
Basics of Common Annuities
The easiest type of annuity to understand is the Single Premium Immediate Annuity (SPIA), in which you give a lump sum to the insurance company and in exchange they give you back your principal plus a growth in an installment payment. Your monthly/quarterly/annually payout is known beforehand. The purchaser is shifting the risk of liquidating the portfolio to the insurance company, as well as, growth (and avoiding losses) of the portfolio.
The second very common type of annuity is the deferred annuity. A deferred annuity is basically an investment account with an insurance company that acts as a hose. You are going to put money into the deferred annuity, either in a lump sum or in installments, by sending money to an insurance company. The money stays in there growing, either at a fixed rate or a variable rate, until you turn on the hose where the money will then come out in equal installments. The build up within the hose may not even reflect market conditions and that is why people buy them. So if you were to give an insurance company $100,000 with some type of rider that guarantees 5% growth. Your “annuity shadow account” could be at $105,000 even if the market dropped 20% however if you go to pull the money out you’d only get $80K minus surrender charges. People purchase these to shift risk to the insurance company since most deferred annuities are coupled with some fantastic riders which may include:
- Guaranteed Minimum Income Benefit – As Defined by Investopedia: Receiving a guaranteed minimum income benefit ensures that an annuitant will receive a payment regardless of market conditions. This minimum payment amount is predetermined by assessing the future value of the initial investment. This option is only beneficial to annuitants who plan to annuitize their annuity.
- Guaranteed Minimum Accumulation Benefit – As Defined by Investopedia : A rider on a variable annuity, which guarantees the minimum amount received by the annuitant after the accumulation period, or a set period of time, is either the amount invested or is locked in gain. This protects the value of the annuity and the annuitant from market fluctuations.
- Guaranteed Minimum Withdrawal Benefit – As Defined by Investopedia: This specific option gives annuitants the ability to protect their retirement investments against downside market risk by allowing the annuitant the right to withdraw a maximum percentage of their entire investment each year until the initial investment amount has been recouped.
What are you giving up? If the market shoots up 22% you won’t see all the gain plus the insurance company gets their expenses off the top first.
Combining a SPIA and a Deferred Annuity to Get a Longevity Annuity
Like a SPIA you are going to give an insurance company a lump sum today for a predetermined installment payout. Like a deferred annuity your payments won’t start till a point in the future. In the examples I have seen online the date is chosen by the purchaser but seems to be after 80.
The main drawback is that if you die prior to the annuitization date the insurance company keeps the money. The main advantage is that if you blew through your retirement money you know you have a new income stream starting on your 80th birthday.
It should be fairly obvious that the longer you wait and the earlier this product is purchased the higher the payment will be and the lower amount needed to fund, respectively. Why? Because the longer you wait the less likely you will survive to receive payout and the earlier you provide the insurance company with the lump sum the longer they will have to grow your money.
Would I Buy A Longevity Annuity?
I have not had the opportunity, nor could I find a way, to play around with the illustration system of the product, as such, I can’t answer the question right now. I would need the illustration system to determine the internal rate of return on the product. My gut tells me that the product is too new, it is in its infancy and in 10 or so years they will start adding cool riders to provide for partial principal repayment upon a premature death.
Have you been approached to buy this product? Do you already own one?