How to Not Outlive Your Retirement Savings

The U.S. Treasury recently amended its rules to encourage workers with retirement plans to purchase life annuities within these plans. Life annuities generally make fixed monthly payments from the date of retirement until the death of the purchaser.

For years, many economists have recommended that workers use all their retirement savings to buy life annuities in order to avoid outliving their savings. Nevertheless, few workers want to put their whole retirement nest egg into a life annuity.

Why? In one word, optionality. Retired workers want to have substantial resources available to deal with medical emergencies or unexpected disasters during their retirement years. Alternatively, retired workers want to bequeath any remaining savings at death to their families, friends and favorite charities. However, if workers buy a life annuity, all payments typically end at death — even if it occurs shortly after retirement.

To achieve their multiple retirement goals, workers should use PART of their assets within their retirement plans to buy a deferred life annuity that starts paying out at age 75,80 or 85. Then they would have the rest of their retirement assets available to deal with medical emergencies or to make bequests at their death.

The recent Treasury rules make it a lot easier for workers to use part of the assets within their 401k or IRA plans to purchase a deferred life annuity at a relatively low cost. For example, according to a New York based insurance company, a man at age 60 can purchase a deferred life annuity with $50,000 from his IRA, and then receive $17,614 in annual income for life starting at age 80.

This type of deferred life annuity, called a longevity annuity, is much less expensive than an annuity where monthly payments start at retirement. A longevity annuity should appeal to workers who believe they have enough retirement savings to last for one or two decades, although they just don’t know what would happen if they lived to age 90 or 100.

In the past, longevity annuities with late-starting payments were constrained by Treasury rules, which required all plan participants to make annual taxable distributions out of their retirement accounts from age 701/2 onwards. Under the amended rules, by contrast, participants may use up to 25% of their retirement account balances ( not to exceed $125,000 ) to purchase longevity annuities without concern about complying with this annual distribution requirement.

Moreover, the amended rules apply to longevity annuities even if they allow the premiums to be returned to the retirement account of an annuitant who dies before receiving any payments under the policy. This optional feature — despite its higher price — should appeal to those retirees worried about dying before collecting anything from the longevity annuity.

In short, the new Treasury rules will encourage plan participants to use part of the assets in their 401ks and IRAs to purchase longevity annuities. Such partial annuitization will help retirees allay their anxieties about outliving their savings, while allowing them to use their remaining plan assets to pursue their other retirement goals.