Guaranteed Lifetime Income Isn’t Free

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Insurance protects against losses – fires, floods or a wrecked car. A client buys insurance to avoid the life-altering consequence of a random loss. In this article, we clarify the costs and the expected payouts from lifetime income insurance through a guaranteed lifetime withdrawal benefit (GLWB). Offering these payouts to retirees who experience low investment returns and a long life isn’t free, although the cost of insurance is often mischaracterized as a fee.

Lifetime income insurance preserves a retiree’s ability to spend a minimum amount each year from a risky investment portfolio. The insurance premium is often characterized as a fee, but the guarantee of lifetime income provides valuable protection to retirees who face the risks of longevity and low portfolio returns. The premium is a transfer from lucky to unlucky retirees and, like any other form of insurance, can improve outcomes for risk-averse retirees.

Imagine a client has saved $500,000 to fund spending in retirement. You tell her she can safely spend about $25,000 each year. She wants to know how confident you are that she won’t run out. You reply that you’re very confident – Monte Carlo simulations show that she has more than a 90% chance of success.

What if the client asked you to instead guarantee that no matter how long she lived, no matter what happened in the markets, she could continue to receive $25,000 each year from a $500,000 portfolio?

You’d hesitate.