Annuitizing Can Be a Longevity Hedge

How long do you plan to live? Is that number slowly increasing every year with medical breakthroughs, healthy living, and staying fit? In today’s era, more people are living longer than ever expected. The question is: “Did you save enough to support 30+ years in retirement?”

Steve Vernon, a retired Watson Wyatt actuary and current fellow at the Stanford Center on Longevity, said, “Many have saved enough for a 1960’s retirement but not the ‘long retirement’ likely to emerge in the 21st century.”

The looming thought of running out of money in your 80s has some people turning to “annuitizing” as a longevity hedge.

Annuitizing happens when you take a lump sum of money (could be from a savings account, brokerage account, IRA, 401k, or even an annuity) and trade it in for a lifetime of insurance-backed equal payments. Think of it this way: A lump sum of money is like a cloud. If that cloud creates a constant sprinkle of rain for the rest of your life, then it has been annuitized.

When you turn the spigot on to receive insurance-backed equal payments for the rest of your life (i.e., when you have annuitized), the insurance company is giving you back your money. Once you outlive your initial deposit, then you start receiving the insurance company’s money. Thus, the longevity hedge.

When initially building the lump sum of money, most people do so in a brokerage account, IRA, or 401k account—but not an annuity. This makes sense because most annuities have high administrative fees and handcuffs that are often referred to as surrender fees. Surrender fees (usually 7% or less) are charged if you need your money back earlier than the annuity allows. The administrative fees run about 3%. Investing your money at a brokerage firm such as Schwab, Fidelity, or Vanguard is usually less than 1%. Since it takes 30-40 years to build a nice retirement fund, the lower expense translates to huge savings after being compounded for many years.

If you choose to receive insurance-backed equal payments for life, make an appointment with an immediate-annuity representative to learn all the details about the annuity. Then consider meeting with a fee-only financial planner for a non-biased second opinion.

Gail Gill, CFP®, Worley Erhart-Graves Financial Advisors

This article was included in the Worley Erhart-Graves Quarterly Newsletter. Download the printable version here.