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.