Learn to Live Well While Living Long

Physician's Money Digest, September 2007, Volume 14, Issue 9

One of the risks that make planning for retirement so difficult is longevity risk—the uncertainty about how long you will live. If you withdraw too much in the early years and then live long, you may run out of money in your later years. On the other hand, if you settle for a lower standard of living and smaller withdrawals in the early years, a lot of the sacrifices would be for nothing if you die earlier than anticipated. To help protect against this risk, a number of insurance companies are introducing what can be called longevity insurance.

Paying Now to Spend Later

At the time you buy longevity insurance, you will turn over to the insurance company a lump sum in exchange for a constant or inflation-adjusted annual income that will start at a specific age and will continue for the rest of your life. For example, if you are 65 now and put $100,000 into such a policy, your policy will probably pay around $80,000 per year starting at age 85.

How much future annual payment your initial payment buys primarily depends on your age and long-term interest rate at the time you buy the policy, as well as the age at which you want payments to start. You can and should also buy an inflation rider, which will make the annual payment grow at your chosen rate—generally between 1% and 5% per year.

The key attraction of the policy is that the payments will continue for the rest of your life. You will never run out of annual income.

How Much to Buy and When

This may sound so good that you may be tempted to put a large part of your nest egg into such a policy. But resist the temptation. Recognize that this is essentially a fixed-income investment. The insurance company will base your future annual payment on the long-term interest rate at the time you buy the policy. Because long-term, fixed-income return is generally significantly lower than long-term expected return on stocks, the more money you put into a longevity policy, the larger your nest egg will need to be to have the same expected total annual income in the future.

For the same reason, you should generally buy such a policy later rather than earlier in your life to avoid limiting your growth potential. The earlier you buy the policy, the less time your money has to grow in other investments. If you can earn a higher return in the stock market between ages 65 and 75 years, overall you will end up with a lot more money and an annual income if you wait until age 75 to buy the policy.

One offsetting factor is that the longer you live, the longer you can be expected to live. So someone who buys a policy at age 75 can be expected to collect payments for more years than someone who buys it at age 65 (assuming both start taking payments at the same age, say 85). This factor will lower future annual payments as you delay buying the policy.

Because of these and other complications, to make the right choice about when to buy such a policy, how much to buy, and when the annual payments should start, you will need knowledgeable independent advice. For most people, trying to make these decisions on their own or with the help of an insurance salesperson is not a good idea.

Chandan Sengupta, author of The Only Proven Road to Investment Success (John Wiley; 2001) and Financial Modeling Using Excel and VBA (Wiley; 2004), currently teaches finance at the Fordham University Graduate School of Business and consults with individuals on financial planning and investment management. He welcomes questions or comments at

chandansen@aol.com.