Earlier this summer the Treasury Department issued new regulations encouraging longevity insurance within DC plans and IRAs — but will that make a difference?
A recent blog post by Steve Utkus, principal and director of the Vanguard Center for Retirement Research, explains that longevity insurance is an insurance contract you buy early in retirement (say at age 65) that isn’t designed to begin paying out monthly income until a much later age, frequently 80 or 85. That’s a point in time at which many projections indicate that individuals might begin running out of their accumulated retirement savings, and might therefore need this source of income — if you’re still alive. Therein lies the rub. Will individuals take the long view and buy insurance that provides a benefit they may never receive?
That’s where the Treasury regulations may help. Under the old IRS minimum distribution rules, if you bought a longevity policy at age 65 with funds from your DC/IRA and you reached age 70-1/2, Utkus explains, technically you’d have to estimate the value of that contract, and that would figure in the amount you needed to withdraw from your other IRA or DC accounts — even if you weren’t receiving money from the contract.
However, under the new rules, Utkus notes, as long as you meet certain requirements (such as investing no more than $125,000 over your life and 25% percent of your account balance), you no longer have to include the annuity contract in any required minimum distribution (RMD) calculation. What this means is that, under the new rules, monies invested in a longevity annuity contract escape the RMD rules.
Utkus also notes that the new rules might help encourage greater take-up of a different annuity contract, called the deferred income annuity (DIA) — which is nothing more than longevity insurance, but with an income that kicks in earlier, such as age 65 or 70. It’s possible that individuals nearing retirement might want to dollar-cost-average some of their IRA or DC plan savings now into a DIA annuity contract — with the income beginning to pay out in in their early retirement years.
Longevity risk — the risk of running out of money in retirement — is a risk that many retirement projection models overlook (or assume away — see my Routing “Slips” column). It’s a very real risk for retirees — and the new rules would seem to smooth the path for some better solutions.
Perhaps more importantly, the introduction of the new rules would seem to provide an opportunity to think about retirement planning in new and different ways. And for advisors, it may present a new topic of conversation with plan sponsors, as well as with plan participants.
