Arcane but Shrewd Retirement Solution?
Tontines might be a nifty idea for retirement income. Too bad they haven’t been legal here for a century.
Tontine is a fancy word for betting on how long you’ll live – in a good way. Here’s the concept in a nutshell: many people pool their money in return for guaranteed regular payouts for life, similar to an annuity.
The people who live to, say 90, will receive ever-increasing financial payoffs, because the number of participants in the pool will invariably shrink over time. The catch is that the investors who die young won’t receive as much income as the men and women who live the longest – but they won’t need the money either.
A new study by the Center for Retirement Research (CRR) takes a close look at an idea that is tossed around among finance experts: modifying tontines to use them as a source of retirement income.
Some criticize them as a dubious investment, but they’ve stood the test of time. King Louis XIV of France was the first monarch to raise public funds using tontines, a 1650s creation of Italian financier Lorenzo Tonti. More than a century later, they caused financial hardship among middle-class investors, laying some of the groundwork for the French Revolution.
Tontines made it into American popular culture in the M*A*S*H* television show. Because Col. Potter was the last man standing among his World War I Army buddies, he got the only remaining bottle of brandy from a cache they’d found and drank while camped out in a French chateau. Tontines popped up again in an episode of The Simpsons: grandpa Abe Simpson and Mr. Burns fight over some valuable German paintings in a tontine their Army unit had created back in World War II.
Credit for the idea of a retirement tontine goes to a paper by two professors at York University in Toronto, Moshe A. Milevsky and Thomas S. Salisbury. In his new report, CRR researcher Gal Wettstein agrees that tontines might be a useful way to get regular retirement income – with modifications.
Tontines’ big advantage is their guaranteed payouts to each investor. But a tontine costs less than annuities, because its investors – rather than an insurance company – bear the risk. A modified tontine for retirees would address their current downside: very old people get the largest payoffs, by default, as others in the pool die, but age and poor health can prevent some from fully enjoying the money. The modified retirement tontine could make equal, regular payments to all the participants over the years – rather than give the biggest payouts to those who live the longest – Wettstein said.
Milevsky and Salisbury have proposed ensuring the equal payments by basing them on the investor group’s overall survival probability. As investors die, Wettstein explains, the total number of fixed monthly payments would naturally decline, leaving enough funds in the pool to continue the equal payments. But the catch is that if everyone in the pool lives into their 90s – longer than average longevity predictions – lower payments would inevitably follow as the pool ran low.
Retirement tontines are still fanciful. But if they were legal, Wettstein wrote, they “would likely make the most sense as part of a larger portfolio.”
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