Longevity risk: How deferred annuities can help your savings last

One of the major challenges when planning your retirement income is to try and ensure you maximise the income you receive from savings while at the same time ensuring your savings last for as long as you do.

There is no simple solution or a one-size-fits-all approach. That said, deferred lifetime annuities could provide part of the retirement income puzzle for many retirees.

What is a deferred lifetime annuity (DLA)?

A DLA is a form of lifetime annuity that will pay the owner a guaranteed income stream, starting at a future date, for as long as they live after that date. This can give people confidence to spend more of their savings in the early, active years of retirement with the security of knowing their money won’t run out. 

There are of course costs and benefits to weigh up when considering a DLA. 

In this article we will look at four retirement funding scenarios, to see how they compare and who they may suit.

1. Individual funding for life expectancy (enjoying higher income but high risk of running out of income)
2. Individual funding for life (sacrificing income to counter the risk of running out of income)
3. Group funding for life through an immediate lifetime annuity (guaranteeing income at the risk of losing your capital if you die early)
4. A combination of individual funding for life expectancy and group funding from life expectancy through a deferred lifetime annuity (sacrificing some income to remove the risk of running out of income while protecting most of your capital against the risk of loss if you die early).

Assumptions

For simplicity, we will consider an example of someone retiring at age 65 with $100,000 in savings who is expected to live on average for 20 years (currently true for an Australian male aged 65, while women can expect to live an extra three years on average).

We will assume people live for between 0 and 40 years and that they pass away each year at the same rate (in the real world they tend to pass away closer to the average but for the purposes of this article this is a reasonable assumption which doesn’t change the underlying outcome).

So, at the start 100% of people will be alive and at the end of 20 years 50% of people will still be alive while at the end of 40 years no people will be alive and people live on average for 20 years.

Again for simplicity, we will ignore future earnings on your savings to make the fundamental lessons clearer.