When we hear about risk, our mind often goes to negative events, like accidents, premature death or disability or a stock market crash.

But there’s one type of risk that seems positive, but can have very negative consequences.  This might explain why many investors don’t see it coming until it’s too late.

It’s called “longevity risk.”

A definition

Living a long time is generally a good thing, with these caveats:  We want to be in good health and have enough money to enjoy life and maintain our standard of living.

The risk of outliving our money is called “longevity risk.”

Quantifying longevity risk

I don’t find statistics about the likelihood of living to a certain age very helpful, because I’m only concerned about my situation.  If you want a summary of these statistics, you can find them here.

I take a practical approach to dealing with longevity risk.  Ask yourself these questions:

• Are you in reasonably good health?
• Are you concerned about outliving your money?
• Does relying on the stock market for your retirement funding create unacceptable anxiety?
• Are you age 70 or older?
• Are you okay with trading the possibility of higher returns from investing in the market for the certainty of a fixed monthly payment for the rest of your life?

If the answer to these questions is “yes”, you should seriously consider purchasing an annuity to deal with your longevity risk.

Types of annuities

There are two types of annuities that can protect you against longevity risk:  Immediate and deferred annuities.  Note that variable annuities are not one of these options.

An immediate annuity requires you to pay a lump sum to an insurance company.  In exchange, you will immediately start to receive a stated monthly payment for a given period of time, or until you die, or until your partner or spouse dies, at your option.

With a deferred annuity, the payment starts at a designated age (typically when you reach 80 or 85) rather than beginning immediately.

Under some circumstances, you can purchase immediate annuities using tax-deferred dollars.  You should check with your tax professional or investment advisor.

Annuity resources

You can be in a world of hurt if you deal with some annuity salespeople. Annuities can be high commission items and there may be a temptation to steer you towards them.

I recommend the annuity specialists at Vanguard.  My personal experience with them was very positive.  Be sure to tell them you’re interested in an immediate or deferred annuity.

Resource of the week

This article by financial journalist, Larry Swedroe, is an excellent introduction to immediate and deferred annuities.