This is the sixth and final article in a series on annuities.
In February of this year, the Internal Revenue Service (IRS) and the Department of the Treasury, in cooperation with the White House, published a series of revenue rulings and proposed regulations designed to encourage annuitization under defined contribution plans. This was one element of the Obama administration’s effort to focus on the policy goal that tax-preferred retirement savings should be used to provide lifetime retirement income. One of the proposed regulations defined a class of products known as “qualified longevity annuity contracts,” or QLACs, which are excluded from the account balance used to determine Required Minimum Distributions (RMDs). This article will provide an actuarial perspective on the development of products that would qualify as QLACs.
Qualified longevity annuity contracts
In response to the “Request for Information on Lifetime Income Options for Participants and Beneficiaries in Retirement Plans” by the Treasury and Department of Labor (DOL) in February 2010, representatives of the life insurance industry requested changes to the RMD rules to facilitate the use of longevity insurance in qualified defined contribution plans. The RMD rules provide for minimum annual distributions from qualified retirement plans based on the fund balance and the age of the participant. The February report from the President’s Council of Economic Advisors, called “Supporting Retirement for American Families” (CEA Report), observed that while the current market for longevity annuities is very small, interest in the product has been increasing. Because longevity annuities typically are purchased at or near retirement but do not begin paying benefits until considerably later, they can be offered at a fraction of the cost of annuities that pay immediate benefits, thus allowing retirees protection against the risks of extended longevity at an affordable price, while also allowing them to retain most of their wealth. By exempting longevity annuities (up to a specified limit) from the RMD rules, it is hoped that individuals under defined-contribution plans will be encouraged to use an “affordable” portion of their account balance to purchase a longevity annuity. The proposed regulations apply to tax-qualified defined-contribution plans under section 401(a), section 403(b), individual retirement annuities and accounts (IRA) under section 408 and eligible governmental section 457 plans. A QLAC may also be purchased in an IRA.
Under the proposed regulations, a QLAC is defined as “an annuity contract (that is not a variable contract under section 817, equity-indexed contract or similar contract) that is purchased from an insurance company for an employee.” That is, under the proposed regulations, a QLAC would exclude variable contracts, equity-indexed contracts or similar products, because they are seen as inconsistent with the purpose of a QLAC, which is to provide a predictable stream of lifetime income. In addition, the proposed regulation notes that exposure to equity-based returns is available through control over the remaining portion of the account balance so that a participant can achieve adequate diversification through means other than the QLAC.
The proposed regulations also provide that, in order to be a QLAC, consistent with the affordability concept, the contract is not permitted to make available any commutation benefit, cash surrender value or other similar feature. As in the case of the limitations on benefits payable after death, these limitations maximize the benefit of survivorship, thus allowing an annuity contract to maximize the annuity payments that are made while a participant or beneficiary is alive. Additionally, the proposed regulation states that having a limited set of product options available to purchasers would make these contracts more readily understandable and enhance product comparability. The proposed regulations provide that a contract must be specifically identified as a QLAC at issue to ensure that the issuer, participant, plan sponsor and IRS know that the rules applicable to QLACs apply.
The proposed regulations further provide that, in order to constitute a QLAC, the amount of the premiums paid for the contract under the plan on a given date may not exceed the lesser of a dollar or a percentage limitation. The proposed regulations prescribe rules for applying these limitations to participants who purchase multiple contracts or who make multiple premium payments for the same contract. Under the dollar limitation, the aggregate amount of the premiums paid for QLACs under a plan may not exceed $100,000. Under the percentage limitation, the amount of the premiums paid for a contract under the plan may not exceed an amount equal to 25 percent of the employee’s account balance on the date of payment. However, if on or before the date of a premium payment, an employee has paid premiums for the same contract or for any other contract that is intended to be a QLAC and that is held or purchased for the employee under the plan, the maximum amount under the 25 percent limit is reduced by the amount of those other payments.
The industry response to the proposed regulations has generally been positive. These have dealt with permissible product designs, encouraging additional flexibility in the types of products permitted; modifications to the limits that the proposed regulations placed on QLAC premiums; technical clarifications to the regulations and coordination with the on-reporting and recordkeeping issues.
QLAC design considerations