When qualified longevity annuity contracts (QLACs) were first introduced more than three years ago, they were hailed as an important new tool for protecting against the risk of outliving retirement savings. Though many insurance carriers have jumped on board and now offer these products, many clients remain on the fence as to whether QLACs belong in their retirement income portfolios.
Of course, there is no such thing as a perfect retirement income planning tool, and since the QLAC is a relatively new product, it’s more important than ever that advisors have a concrete understanding of the potential benefits—as well as the potential objections—to including a QLAC in a client’s retirement savings account.
A QLAC is an annuity contract that is purchased within a traditional retirement plan (whether it’s a 401(k), 403(b) or traditional IRA), under which the annuity payments are deferred until the client reaches old age in order to provide retirement income security late in life. Payments must begin by the month following the month in which the client reaches age 85.
The value of the QLAC is excluded from the retirement account value when calculating the client’s required minimum distributions (RMDs) once the client reaches age 70½, though the client is limited to purchasing a QLAC with an annuity premium value equal to the lesser of 25% of the account value or $125,000.
One of the primary motivations for purchasing QLACs exists because the value of the QLAC is excluded from the retirement account’s value when calculating the client’s RMDs. This, of course, allows the client to reduce his or her current tax liability by reducing the amount of his or her current RMDs.
QLACs are also less expensive than a traditional single premium annuity product that begins payouts immediately. As a result, QLACs generally allow a client to generate a larger payout in the future—estimates provide that investing around $80,000 at age 70 will produce an annual income stream of about $12,850 for a man and $11,500 for a woman at age 80. Conversely, the same investment in an immediate annuity would likely produce annual income of about $6,150 for the man and $5,750 for the woman. This provides greater opportunity to invest a larger pool of the client’s retirement assets elsewhere.
Further, QLACs generally remove the responsibility for investing a portion of the client’s retirement assets later in life—many clients may reach an age where they no longer want the responsibility of managing a large pool of assets. The QLAC allows the client to abdicate some of his or her investment responsibility without fear of running out of money late in life.
QLACs can also allow a client to begin claiming Social Security benefits earlier in life, with the expectation that he or she will rely on the QLAC later in life to supplement the reduced Social Security benefit later in life.
If the client claims Social Security benefits early in retirement, the amount that must be withdrawn from retirement accounts early is reduced and a larger portion of retirement savings can be left in tact to grow—potentially generating a higher account balance in the long run.
For many clients, the biggest objection to purchasing a QLAC is the loss of control over a chunk of their retirement assets for what could possibly be a stretch of many years. This feeds into the client’s fears that he or she may never live long enough to actually need the QLAC funds—meaning that the purchase will have amounted to nothing more than an insurance policy purchased within a retirement account.
Inflation concerns can also present a risk for clients—while some annuity products contain inflation adjustment features once payouts begin, the QLAC (in its current form) is more similar to an immediate annuity that simply pays a fixed dollar amount each month after the deferral period (during which inflation protection is generally not offered). Depending upon the future rate of inflation, this could decrease the value of those eventual payouts, especially given the potentially extended deferral period.
Some clients may also question the returns that can be provided with QLAC—in the low interest rate environment of recent years, it may be difficult to generate a return on a QLAC that exceeds that of any other conservative investment product—supporting the client’s potential objection that this is more of an insurance product, rather than a long-term investment.
Whether a QLAC belongs in any individual’s retirement planning arsenal is a question that must be addressed at the individual level—while the potential objections are significant, so are the potential benefits—making a cost-benefit analysis more important than ever with this product.
Originally published on Tax Facts Online, the premier resource providing practical, actionable and affordable coverage of the taxation of insurance, employee benefits, small business and individuals.
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