New Ruling From Treasury Dept. Enables 'Longevity Insurance' Annuities

July 16, 2014

It's the retirement doomsday scenario: outliving your retirement savings. But in this era of prolonged low interest rates, a recent, severe recession that forced millions to cash in part of their retirement savings, reduce or put off contributions altogether, it's a real concern.

Add to that the fact that Americans are living longer and longer into retirement and longevity risk - the risk of living longer than your money - becomes an increasingly present concern.

Historically, of course, we've had annuities to help as a hedge against longevity risk. These are insurance products that are designed to convert a lump sum into a guaranteed steady stream of income - either immediately or at some deferred date. Many people choose some form of a guaranteed lifetime income. That is, a contract with the sponsoring insurance company that guarantees a specific income to the annuitant for as long as the annuitant lives. Others choose to keep the stream of income going for the joint lifetimes of the annuitant and a spouse or other individual, such as a child or grandchild.

The appeal of annuities, however, has been limited, because RMD (required minimum distribution) rules forced annuity owners to begin taking out income shortly after they turn 70½.

A brand new ruling from the Department of the Treasury, however, cuts retirees some slack. The new rule relaxes the RMD requirements and allows annuity owners in some circumstances to allow their annuities to compound, tax-deferred, until age 85.

The new rules allow participants in retirement plans to commit up to $125,000, or 25 percent of their account balances (whichever is less) to purchase a special kind of annuity. The Treasury intends to adjust the maximum dollar premium along with inflation over time, in increments of $10,000.

These particular annuities will not be subject to the usual RMD rules that force retirees to begin drawing down income (and incurring taxes on that income) by April 1 of the year following the year in which they turn age 70½.  Instead, these annuities can be allowed to grow unmolested until the annuitant turns 85 - at which time, an actuarially sound lifetime income calculation will yield a much larger monthly income than it would at age 71 or 72.

The new rules will likely make annuities a much more common option in 401(k)s and other qualified retirement plans than they currently are, though it will take some time for plan administrators to get approval and roll out annuity products that comply with the Treasury Departments' rules for these products.

One possible application: Using these annuities as a 2ndtier 'bucket of money' to kick in when other shorter-term forms of savings approach exhaustion. The presence of a longevity insurance annuity guaranteed to begin generating income not later than age 85 may help the retiree feel better about spending a bit more in earlier years than he or she may, otherwise.

This particular type of annuity may be of particular interest to women, who tend to live several years longer than men, and are therefore more vulnerable to longevity risk.

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