What is longevity risk in relation to annuities?

Longevity risk specifically refers to the risk that an individual will outlive their financial resources, particularly in the context of retirement planning. As people are living longer due to advancements in healthcare and living conditions, the concern arises that individuals may exhaust their savings before they die. Annuities are designed to mitigate this risk by providing a guaranteed income stream for a specified period or even for the lifetime of the individual, thereby addressing the financial uncertainty associated with living longer than expected.

In retirement income planning, understanding longevity risk is crucial as it impacts how much individuals need to save and how they should allocate their assets to ensure a sustainable income for a potentially extended period. Annuities play a significant role in alleviating this concern by transforming a lump sum of money into a predictable income, ensuring that individuals do not run out of funds as they age.