The Pitfalls of Longevity Annuities in 401(k)s

Longevity insurance may help ensure you don't outlive your money. But is it worth the risks?

Jul 26, 2014 at 8:00PM
Birthday Grandma

Credit: Flickr user Samdogs.

The unpredictable economy has sparked many discussions about what, if anything, can be done to ensure guaranteed "paychecks" during retirement. In fact, the fear of running out of money in retirement now even supersedes the fear of death, according to a survey by Allianz Life Insurance.

Well, it seems insurance companies are aiming to ease people's fears by offering "longevity annuities" in retirement plans. Here's how they work: 401(k) and IRA account holders can use no more than 25% of their total account balances or $125,000 (whichever is lower) to buy the annuity. Purchasers typically make a one-time premium payment later in life, which in turn allows them to begin collecting guaranteed payments as late as age 85. The size of the income payout adjusts based on how old you are at the time of purchase and how soon you begin taking income.

For example, according to MetLife estimates, a man who pays $50,000 for a longevity annuity at age 50 could start receiving annual income of $43,000 at age 85, assuming an inflation rate of 2.5% per year. If he only waits until age 80 to start taking income, his annual payout is reduced by nearly half to $23,500.
This may look like a retirement guarantee at first glance, but in reality, annuities are complex and don't often provide the simple "guarantee" they promise. Annuities are only backed by the claims-paying ability of the policy-issuing insurance company, which may or may not have good financial standing in future years.

Due to the lack of an actual guarantee, among other issues, there have been heated debates over whether this supposed solution is wise and will indeed ease people's fears about going broke in their golden years. Until recently, rules prevented annuities from being widely used in 401(k) plans and IRA accounts, because those accounts come with required minimum distributions (RMDs) starting at age 70-1/2. However, the U.S. Treasury Department and the IRS have recently announced new tax rules that promote a favorable union -- maybe.

Now, a distribution used to buy a longevity annuity is exempt from RMD requirements. This means that you are able to put aside your tax-free dollars for a longer period of time. This may be a tax victory, but whether or not it's a retirement savings win is doubtful, because not many retirement plan administrators find them favorable enough to offer them.

However, if you are offered a longevity annuity, be sure to do your homework before signing on the dotted line. Ask the following questions.

What insurance company is guaranteeing this plan? What happens if that company goes bankrupt?
There is currently no federal program in place that protects consumers from insurance-company bankruptcies similar to how the Federal Deposit Insurance Corporation (FDIC) helps protect account holders against bank failures. Be sure to inquire about the possibility of a state guarantee from the Insurance Guaranty Association.

What happens if I die before my first payment?
If you die before you start receiving payouts, the entire balance of your account will be lost. In that case, the insurance company would likely take control of the money in your account. Some companies offer additional coverage in the form of beneficiary riders. With this rider in place, your beneficiary will still receive some type of payment upon your premature death. However, some only provide for a return of the premium (or money) you invested.

For example: Assume you are 65 today and put in a lump sum of money in order to guarantee an annual payout 20 years down the line. Unfortunately, you pass away at age 84 -- one year before those benefits kick in. If your policy has a "return of premium" rider, your heirs would get back only the money you invested, and that's it. You've just given an interest-free loan to the insurance company for 19 years!  

Will my payments keep pace with inflation?
Annuity payments are based on today's interest rates. As a result, today's annuity purchasers may be buying very expensive annuities unless interest rates remain stable or decrease during the term of the annuity payments; this is generally an unlikely outcome, though interest rates will probably be higher in 10 or 20 years than they are now. Any future increase in inflation will erode the purchasing power of an annuity purchased today, unless that annuity adjusts for inflation -- this is an available feature, but it's somewhat expensive.

At the end of the day, the most important thing is to reach your retirement goal in the most efficient, least restrictive manner. On the surface, annuities may seem like a good tool to include in your portfolio, but if you look closely, you may find that they have no place in your retirement planning. A professional investment advisor can help you decide whether a longevity annuity makes sense for you and your portfolio.

Risk-free for 30 days: The Motley Fool's flagship service
Tom and David Gardner founded The Motley Fool over 20 years ago with the goal of helping the world invest...better. Their flagship service, Stock Advisor, has helped thousands of investors take control of their financial lives and beat the market. Click here to sign up today.

The Mutual Fund Store has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.

Compare Brokers