Lifetime Income vs. Lump Sum Payouts: You May Live Longer Than You Think

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My parents are in the midst of planning their retirement payout structure. I don’t know about everyone else, but in my mind I tend to plan to live to pretty much exactly age 80. Early death is depressing to think about (even though I have term life insurance), but what about the other end? The Statistical Ideas blog had a timely post about longevity risks and lump-sum payouts which contained a “death table” (horrible name) for people born in 1950. I’m going to paraphrase the explanation in a way that makes more sense to me.

• Out of every 100 people born in 1950, roughly 1/3rd are expected to die by age 65. (Blue)
• If you are in the group alive at 65, your life expectancy is now age 79. That is, half of that group will die before 79. (Green)
• But, that also means you have a 50% chance of living past 79. If so, you will live to somewhere between 80 to 110. In other words, possibly a really long time! (Red)

If you are a couple, then the odds of at least one of you living a really long time is even higher. Let’s take a couple, one male and one female, who are both age 65. According to this Vanguard longevity calculator, there is an 89% chance at least one will reach age 80, and a 45% chance at last one will reach age 90. If you are younger, your life expectancy is even longer; enter your age(s) into the calculator.

Here’s my mental shortcut. For an individual that is 65 today, there is roughly a 50/50 chance they will reach age 80. For a couple both at 65, roughly a 50/50 chance that at least one person will reach age 90. Putting it this makes make either scenario equally likely and would push me to plan accordingly. On one side of the coin flip, you have to enjoy life now! On the other side, you need to be prepared.

This longevity risk needs to be accounted for when you give up pensions or annuities that offer you a guaranteed income for life. A lump sum payout may sound attractive, but be very careful. Have any annuity and pension buyout offers analyzed and checked by an unbiased third-party. It is a big decision and may be worth paying an expert for their time.

Here’s a sad story of lowball buyout offers for lead-paint victims. Not to say all lump-sum offers are this bad, but it serves as a warning to make sure you understand what you are giving up.

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1. Unless we get seriously ill, we’ll probably live past 75,too, which means we need to plan seriously for our retirement. I’d love to get a ‘monthly rent’ from all the money, a lump sum is great if you can really really budget properly.

2. Mike says:

Do you mean one third expects to die by age 65? I wonder what the number is for those born in the 70’s and 80’s. And more importantly what is the number for those born in those days and who are currently alive.

• Yes, error corrected thanks! Use the Vanguard longevity tool linked in the thread, born in the 70s and 80s your life expectancy is even higher. There is a 11% chance that either my wife or I will live to 97! (another 60 years). 42% chance one of us will live to 90.

3. Zach says:

The Washington Post story was really depressing – and I had no idea Freddie Gray (whose death sparks protests in Baltimore) and his sister had been affected by both lead poisoning AND predatory financing companies.

4. nell says:

I think this should be 1/3rd – “Out of every 100 people born in 1950, roughly 2/3rd are expected to die by age 65.”

• Ack, you’re right. Initially I had written 2/3rd will live to 65, but that wasn’t really what was represented by the blue. So I had to change the numbers to deaths and forgot to convert that one back.

• nell says:

I’m relieved now, because I just turned 65 🙂

• Haha, you’re in the clear no matter what then. 🙂 May you live long and prosper.

5. rifka says:

With only 1/3 living past 65, I could see why most people would forgo an annuity. But I guess if you believe you’ll be healthy, it’s a good gamble. If you are not, you will not recoup what you spent on the annuity and (if you live!) you also may not have the pocket money to pay for all the medical expenses. It is interesting — you may run out of money paying off medical expenses, but I guess the annuity money would be protected? Can collectors come after your annuity payments? I wonder.

• Actually it is 2/3rd living past 65, and if you made it past childhood your odds are much better.

The money for medical expenses is a concern, which is why some people recommend (1) only annualizing part of your money and (2) bundling with a long-term care policy. I know that annuities have different creditor protections than other investments, but I don’t know the specifics myself.