For those who always say that media outlets never publish good news, here's something to consider: People are living longer. According to a report from the National Center for Health Statistics, the average life expectancy has risen by about five years since 1975. Although the bulk of this gain is a result of reductions in infant mortality, which tends to have the greatest impact on most life expectancy averages, data on life expectancy for 65-year-olds still shows an increase of more than two years over that time period. Seniors turning 65 can expect to live between 18 and 19 more years on average.
It's hard to say that living longer is anything but good news for everyone. However, life expectancy only measures quantity of life; it doesn't say anything about quality. Longer life gives people more time to enjoy life's experiences and spend time with loved ones, but that extra time also brings extra expenses that people must take into account. The challenges faced by today's seniors are challenging the framework of the life cycle traditionally followed by most Americans.
Earning and spending
In terms of economics, one can split a person's life into three stages. For the most part, children and adolescents do not work or otherwise earn income; their expenses are borne by their parents or caretakers. This first stage extends into young adulthood for many people who choose to obtain advanced degrees and other additional education.
Adults, on the other hand, start doing things that allow them to earn money to meet their own living expenses. In this second stage, many adults are fortunate enough to make more money than is necessary for their immediate needs; this surplus money can either be used to repay student loans and other debt from the first stage, or be set aside for future needs.
At some point, most adults choose to stop working and retire, entering the third stage of their economic lives. During this time, retirees are entirely dependent on the resources they have set aside from earlier in their lives, whether those resources come in the form of their own savings or through regular income like pension and Social Security payments.
Increasing life expectancies have lengthened the time many Americans spend in the third stage, which in turn creates the need for adults to save more during their working years. The only alternatives are becoming dependent on family members for support or choosing to work later in life than one would prefer.
How immediate annuities can help
Part of the challenge in planning for retirement is trying to figure out how much you should save. If you knew exactly how long you were going to live, you could just estimate your living expenses over a set number of years and do simple calculations to determine how much money you should have before you retire. Since you don't know how long you'll live, however, you would have to save a relatively large amount of money to be absolutely certain you could afford all of your expenses, even if you live to 100 or more. The fear of running out of money is probably the top concern among retirees, who have few options for generating additional money, even if they desperately need it.
There is a way to ensure that you will receive a constant stream of income for as long as you live. Annuities are contracts offered by most life insurance companies, including AIG (NYSE:AIG), Hartford (NYSE:HIG), and MetLife (NYSE:MET). In addition, many low-cost financial services companies, such as Vanguard and TIAA-CREF, offer annuities as investment options. In exchange for your payment of a premium for the annuity contract, the life insurance company agrees to make periodic payments back to you, following the specific terms to which you agree in your contract.
The annuities with which many people are most familiar are called deferred annuities; in these arrangements, you pay a premium now, but do not begin taking any payments back from the life insurance company until a later date. Until you begin taking payments, your premium is invested according to options you choose when you buy the contract. You can generally choose to deposit additional money to your deferred annuity at any time. As with other life insurance products, deferred annuities have tax-favored status; the income that your premium earns before you start taking payments is not subject to current income tax, so the deferred annuity enjoys tax-deferred growth until you start withdrawing money from it.
With variable deferred annuities, you can choose a wide variety of underlying investments to help make the annuity's value grow more quickly than a traditional fixed annuity, which generally produces returns similar to fixed-income investments like bonds. When you later start taking payments, the periodic payments will be based on the total accumulated value of the annuity, including both your initial premium payment and any earnings on that premium. You will also pay tax on a portion of your annuity payment, reflecting the income on your premium that temporarily escaped taxation before.
With immediate annuities, on the other hand, the insurance company starts making payments back to you right after you pay your initial premium. Even though there is no accumulated income at the time you start receiving payments, you will still incur tax on a portion of each payment, because your premium continues to generate income even after payments begin.
Many financial planners recommend against immediate annuities, arguing that once you begin taking payments, you lose some flexibility in managing the annuity as an investment. However, the primary advantage of annuities over other savings vehicles is the ability for investors to reduce the risk of their outliving their savings by taking advantage of their annuity's contract payout provisions. The second part of this article goes through these options in greater detail, and discusses some of the advantages and disadvantages of annuities.
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Fool contributor Dan Caplinger hasn't decided whether gambling on his life expectancy is such a good idea, but he is certain that he doesn't own shares of any of the companies mentioned in this article. You can count on the Fool's disclosure policy for as long as you live.
