(PUB) Morningstar FundInvestor

August 2 014

Morningstar FundInvestor

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how long they have to plan for their savings to last,” Blanchett says. “That is why longevity annuities are so attractive.” Michael Kitces, a partner and director of research for Pinnacle Advisory Group, agrees that longevity annuities beat immediate annuities when it comes to hedging against longevity risk. The best candidate for such a product, Kitces says, “is someone who is specifically afraid of living well into his 90 s and beyond and is concerned [whether] he’ll have enough money to fund a retirement that long.” Balancing Behavioral and Financial Factors Despite those attractions and the fact that longevity annuities will be more readily available via IRA s, the products aren’t without potential drawback. Just as a purchaser of an immediate annuity faces the chance that he will die before receiving a fair share of payments, the buyer of a longevity annuity risks dying before or shortly after payments commence. The psychological risks of parting with a sum of money that never provides a benefit is one reason that many retirees avoid the products, even though data indicate that annuities can be an attractive part of retirees’ tool kits. Kitces points out that some products do offer a death- benefit guarantee, so that your estate receives at least your principal if you never receive payments from the annuity. But, Kitces says, adding in this protection will also reduce the benefits you’d receive if you lived. “If you get guarantees for both sides— if you live, and if you die—you just end up with a very mediocre combination guarantee that doesn’t do much for either.” Kitces also noted that, given today’s low interest rates, longevity annuities don’t necessarily offer an attractive “return” relative to conservative invest- ment types. In other words, unless you live a very long time and are able to wring a large amount of payments from the annuity, you may have been better off avoiding the products and just investing conservatively instead.

But Blanchett believes that would-be purchasers of longevity insurance are better off thinking of it as an insurance product. You may well lose money on the deal, but you’ve obtained something that’s impossible to quantify: peace of mind. “Someone buying this should be buying it as a pure insurance policy and shouldn’t be too focused on the internal rate of return,” he says. “I’m not saying one shouldn’t be aware of the cost, but it’s only part of the equation.” How Much Is Enough? Assuming one has decided to steer a portion of a portfolio to a longevity annuity, what is the right amount to steer toward it? For Blanchett, the timing of the start date is the key swing factor. The further the start date (and remember, 85 is the latest date for payments to start for some- one buying a QLAC within an IRA ), the smaller the allocation should be. He suggested that for a 65 -year- old purchasing a QLAC that will commence payments at age 85 , 5% to 15% of the portfolio is a reasonable ballpark percentage. He also urged would-be annuity purchasers to factor in other certain sources of life- time income, such as Social Security, when deciding how much to sink into a longevity annuity. Kitces notes that many purchasers of longevity annui- ties think about the baseline living expenses they’d like the product to supply and use that to inform how much they sink into the contract. But he also points out that even as some longevity policies guarantee a cost-of-living adjustment once payments commence, they don’t guarantee inflation adjustments between the time you purchase them and the time payments start. That means that forecasting how much you’ll actually need “turns into a bit of a guessing game.” Blanchett also points out that the market for these products is still pretty thin and there aren’t nearly as many products available as in the single-premium immediate annuity space. But given the new Treasury Department ruling, he says, “I’m guessing this will improve as [the products] increase in popularity.” œ Contact Christine Benz at christine.benz@morningstar.com

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