Head-to-head, longevity annuities represent a better deal than bonds and immediate annuities in a retirement portfolio, but still lag equities and the value of deferring
Social Security income as long as possible.
“Longevity annuities look much better than bonds and superior to immediate annuities, but they're arguably inferior to equities, if you're really willing to let your money sit for 20 years and not touch it. And it's absolutely dwarfed by the value of delaying
Social Security,” said Michael Kitces, partner and director of planning research at Pinnacle Advisory Group.
Longevity annuities are also known as deferred income annuities. Investors put down a lump sum of money and defer payout from the annuity until a period in the future, as much as 10-20 years.
They deliver magnified payouts, where investors can get three, four, even five times their principal back by deferring income for 20 years, according to Mr. Kitces, who made his comments at the American Institute of Certified Public Accountants' (AICPA) annual advanced personal
financial planning conference in Las Vegas.
“They're actually a very good way to align retirement income,” he said, because investors are covered if they live a long time, but if they die before receiving a payout the money wasn't needed. “If you live you win, if you die you don't care,” he said.
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PAYOUTS FOR LIFE
Longevity annuities “dominate” relative to a purely fixed-income portfolio because insurers are able to offer mortality credits to investors, Mr. Kitces said. Mortality credits make it possible for investors in the annuity pool to get more than they would individually, because the ones who die essentially subsidize the ones who live. And because deferred-annuity investors push payment out for such a long time, increasing the likelihood of death, those credits are very back-loaded and contribute to high payout rates.
Mortality credits are worth more in a low-interest-rate environment, in terms of their relative impact on how much more income investors get, Mr. Kitces said.
Further, using a bond ladder to produce income in a retirement portfolio is limited from the perspective of time — if an investor lives one year past the bond ladder, that investor will be broke, whereas longevity-annuity payouts last for life.
IMMEDIATE ANNUITIES
Longevity annuities also beat out immediate annuities as a retirement strategy in most cases, according to Mr. Kitces. As an example, an investor who puts $100,000 into a single premium immediate annuity (SPIA) at age 65 would begin receiving monthly payments of $478.91 that year; the same investor who put money into a longevity annuity at 65 but began receiving payments at age 75 would receive $934.18, a 95% increase, and $2,656.20 if delayed until age 85, a 455% increase, according to annuity quotes cited by Mr. Kitces.
If an investor were to wait until age 75 to buy an SPIA, and invest his money in the stock market at age 65 instead, that investor would need a 13% rate of return on investment to generate the assets necessary to achieve a comparable payout to a longevity annuity.
“You can replicate the guarantees of immediate annuities, with less capital outlay,” Mr. Kitces said. They also provide greater liquidity than SPIAs during intervening years before payout, and eliminate guesswork for a client's investment time horizon because advisers know how long to invest for (age 85, for example).
The one area in which an SPIA could prove superior, Mr. Kitces said, is around inflation. Longevity annuities could come with inflation protection features, but advisers would have to essentially guess the inflation rate over a 20-year period before payouts were to begin, when putting together a financial plan. With SPIAs, however, inflation protection begins immediately so advisers wouldn't have to guess.
EQUITIES, SOCIAL SECURITY
When it comes to equities, though, longevity annuities don't quite stack up yet because the stock market has delivered higher returns than the annuities over long time periods, Mr. Kitces said. Examining rolling historical stock-market returns over a 35-year time horizon shows that returns have never dipped below the longevity annuity hurdle rate of 5.4%, going back to 1871. Looking at 20-year historical returns achieved a similar result — the stock market only dipped below longevity annuity returns only a few times.
“We're not quite there on payout rates yet, but just wait,” Mr. Kitces said. If interest rates go up enough, longevity annuities could end up beating stocks in terms of payout, which would prompt a shift in discussion around retirement income and trade-offs.
Also, “Social Security absolutely obliterates a longevity annuity,” he added. Buying a longevity annuity at age 62 and deferring payout until age 70, the latest at which one could delay Social Security payouts, would provide a payout rate of about 4%, whereas delaying Social Security delivers the equivalent of about a 9% return.
Therefore, head-to-head, investors should always choose to delay Social Security over buying an annuity, Mr. Kitces said.
