Category: Longevity Insurance

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Annuities Deferred Income Annuities Income Tax Planning Long-Term Care Longevity Insurance Retirement Income Planning

The Perfect Storm for a Tax Credit Longevity Annuity Plan

The Perfect Storm
The United States Capitol Building

With momentum building for tax reform, concerns about the long-term sustainability of Social Security, widespread lack of long-term care protection planning, and the failure of 401(k) plans to replace private pension plans that were once a cornerstone of our parents’ and grandparents’ retirement income, we have the perfect storm for Congress to introduce, and the President to sign, Tax Credit Longevity Annuity Plan legislation.

Similar to a qualifying longevity annuity contract, or QLAC, which was enacted in 2014, a Tax Credit Longevity Annuity Plan, or TCLAP, (my creation) would use one or more deferred income annuities, or DIAs, offered by life insurance companies as its chassis.

Deferred Income Annuity Advantages

DIAs offer three advantages over traditional savings vehicles which make them attractive as the foundation of a comprehensive retirement income planning strategy:

While payment options include a fixed term or lifetime, most people opt for the latter. When you purchase a DIA, you choose a deferred income start date. Once payments begin, they continue for the life of the annuitant and a joint annuitant if applicable assuming a lifetime payment option is chosen.

  • Locked-in savings plan

A DIA is irrevocable. Unlike traditional retirement savings plans from which funds can be withdrawn before retirement resulting in premature depletion, you enter into a contractual relationship with a life insurance company when you purchase a DIA. The contract provides that you will receive a defined monthly income beginning on a specified future date in exchange for a specified premium. Unless there’s a return of premium provision included in your contract, your premium is nonrefundable.

Subject to the claims-paying ability of individual life insurance companies, funds allocated to DIAs are protected against stock market declines. Individuals who purchase DIAs will receive a contractually-fixed amount of lifetime income beginning on a certain date even if there’s a major stock market correction.

12 Proposed Provisions

A Tax Credit Longevity Annuity Plan, or TCLAP, if enacted, would expand upon, and overcome, various shortcomings associated with QLACs. Periodic income payments would be similar to comparable non-TCLAP DIAs. There would be 12 proposed provisions as follows:

1.  Nonqualified Investment

Most people associate retirement planning with investing in qualified retirement plans such as 401(k)s and IRAs. To the extent that you make deductible contributions to these types of plans, 100% of your distributions will eventually be taxable. This wouldn’t be so bad if you invested the tax savings from your deductible contributions and used them for retirement, however, most people don’t do this.

Unlike a QLAC which can only be used inside retirement plans, the source of TCLAP investments would be nonqualified funds. Although income payments would still be taxable, a sizable portion would be exempt from taxation. This is due to the fact that an “exclusion ratio” is applied to nonqualified DIA distributions.

An exclusion ratio reduces the amount of taxable DIA distributions by the portion of each distribution that’s deemed to be a return of investment. The ratio is equal to your investment in the contract divided by your expected return based on your actuarial life expectancy at the age that you begin receiving distributions.

Approximately 25% to 65% of each income payment can be excluded from taxation depending upon your age when you begin receiving your distributions. The percentage that’s initially used will continue until you reach your actuarial life expectancy and your cumulative payments equal your total investment in your contract. 100% of future payments are taxable once this occurs.

2.  Additional Premiums

While several DIAs allow for subsequent investments in future years, there are several that limit investment to a single premium. Given the fact that the purpose of a TCLAP would be to meet sustainable income needs not fulfilled by other sources such as Social Security, a single premium would generally be insufficient.

Given this reality, a TCLAP carrier would accept initial and subsequent premiums up to a specified period, e.g., two years, prior to the income start date.

3.  Investment Tax Credit for Initial and Subsequent Investments

One of the most compelling ways to incentivize behavior is with tax credits. A tax credit, unlike a tax deduction which is dependent upon one’s marginal tax bracket for determining the amount of tax savings, is a direct offset to tax liability. Most tax credits today, with the exception of residential energy and credits for all-electric and plug-in hybrid vehicles, the latter of which can be as much as $7,500, are subject to income limitations.

Assuming that the purpose of tax reform is to benefit the middle class, the long-term sustainability of Social Security is questionable, and Congress wants to encourage and promote self-funded private pension plans, an investment tax credit equal to a percentage of initial and subsequent investments makes sense. The percentage would be modest to compensate for the fact that a sizable portion of income distributions will be nontaxable.

In order to encourage individuals to direct a high level of their savings into TCLAPs beginning at an early age to produce a significant amount of sustainable income to pay for their retirement expenses, I would recommend that Congress support a tax credit equal to 8% of initial and subsequent investments for individuals who aren’t qualified retirement plan participants and 4% for those who are. This would go a long way toward subsidizing investment in TCLAPs that wouldn’t otherwise be made in most cases.

4.  Annual and Lifetime Investment Limitation

Given the fact that a sizable investment in a fixed income annuity such as a DIA is required in order to receive a meaningful amount of income, there should be a reasonably high limit on the amount of allowable initial and subsequent investments in TCLAPs.

I would propose a limit of $100,000 in the initial contribution year and $50,000 in subsequent years with a lifetime limit of $750,000 per household. This would result in a maximum investment tax credit of $8,000 (8% x $100,000) or $4,000 (4% x $100,000) in the initial year and $4,000 (8% x $50,000) or $2,000 (4% x $50,000) in subsequent years depending upon participation in a qualified retirement plan.

5.  Minimum Investment Amounts

As stated in the previous section, a sizable investment in a DIA is required in order to receive a meaningful amount of income. The amount of income in each situation is different depending upon each individual’s retirement income planning needs, the percentage of total income that’s targeted from sustainable income sources, and the amount that will be provided by other sources, e.g., Social Security.

Having said this, minimum investment amounts need to be established that will help meet one’s planning needs as well as make it profitable for life insurance companies to underwrite TCLAPs. I would suggest a required minimum investment of $50,000 in the initial contribution year and $10,000 in subsequent years in which an individual decides to add funds to his/her TCLAP. These amounts would be applied to all of a household’s TCLAPs if more than one is owned.

6.  No Income Restriction

Unlike many tax credits, including the retirement savings contributions credit that’s subject to a maximum income limitation, this wouldn’t be the case for TCLAPs. Everyone, regardless of income level, needs to save for retirement. To the extent that there’s a vehicle for doing so that provides sustainable lifetime income protection from stock market corrections, we shouldn’t be limited by income from making that investment.

7.  Maximum Income Start Age

Since a TCLAP would be a double tax-favored plan with its built-in exclusion ratio and legislated-investment tax credit, a maximum income start age would need to be included in order for taxation on the nonexcluded portion of income payments to begin at a reasonable time from an IRS perspective.

Given the fact that most nonqualified DIAs provide for a maximum income start age of 85 to 95, I would recommend a maximum income start age of 75 for a TCLAP. Although most people would opt for a starting age approximating the traditional retirement age of 65, this would encourage purchase of multiple contracts with different starting ages to meet changing income needs in retirement.

8.  Minimum Income Start Age

To encourage individuals to defer their income start date for a reasonably long time to increase their periodic income payments and to discourage investment for the sole purpose of obtaining the tax credit, a minimum income start age would need to be legislated. I would recommend that the later of age 60 or 10 years from the initial purchase date be used for this purpose.

9.  Flexible Income Start Date

Flexibility is important since TCLAPS would be used for retirement planning. This includes the income start date since it’s a known fact that people often retire earlier than planned for various reasons. Likewise, there are situations where individuals either elect or are forced to extend their working years.

Recognizing this, subject to IRS’ maximum and minimum income start ages (see #7 and #8), accelerated and deferred income start dates could be provided for as follows:

  • Earliest income start date: 1 year after the last premium payment
  • Latest income start date: 5 years after the original income start date

10.  Larger Return of Premium Than DIA Contracts

When you purchase a traditional DIA or QLAC, you can include a return of premium provision in your contract in exchange for a small reduction in your periodic income amount. This provides for an income tax-free death benefit payable to one or more beneficiaries equal to the amount of investment in the contract in the event that the annuitant(s) die before income payments begin.

Once again, to encourage individuals to take advantage of TCLAPs, I would recommend that the return of premium be increased from the traditional 100% of investment amount to 125% of all investments made at least five years before the death of the annuitant or surviving annuitant in the case of joint annuitants. The purpose of the five-year rule would be to remove the incentive of individuals in declining health who wouldn’t normally purchase a DIA from obtaining a guaranteed 25% return on investment in a short period of time for their beneficiaries.

11.  Ability to Use Funds for Long-Term Care Protection Prior to Income Start Date

In the event that one or both annuitants, as applicable, meets one of the two traditional long-term care insurance benefit triggers, funds could be withdrawn from a TCLAP tax-free to pay for long-term care expenses. The two benefit triggers are:

  • Inability to perform two out of six of the activities of daily living (ADLs): bathing, continence, dressing, eating, toileting, and transferring
  • Cognitive impairment

A TCLAP owner would be able to take advantage of this provision after being a TCLAP owner for a specified period, say ten years. At that time, upon submitting periodic proof of meeting one of the two benefit triggers from a physician, a TCLAP owner would be paid a tax-free cash benefit of up to $5,000 per month to be used for long-term care expenses with a lifetime limit of 125% of the cumulative TCLAP investment amount.

Long-term care payments would be in lieu of receiving lifetime income beginning at the contractual income start date. If the annuitant dies before receiving 125% of the cumulative investment amount, the remainder would be paid to the individual’s beneficiaries as a tax-free death benefit.

12.  Required In-Force Income Illustrations and Income Benefit Statements

Before you invest in a DIA, your life insurance agent will prepare an illustration showing the amount of periodic income that you will receive beginning on a specified date assuming that you make your investment today. When permitted, the illustration can also include planned future additional premiums.

Given the fact that a TCLAP carrier would be required to accept additional premiums (See #2) and it’s important to know the amount of additional periodic lifetime income that you will receive, insurance companies would be required to provide in-force income illustrations upon request.

Confirmation and annual statements would also be required to show original and revised periodic income payment amounts resulting from additional contributions beginning at the contractual income start date.

Timely Idea

The proposed “Tax Cuts and Jobs Act” introduced by House Republicans on November 2nd includes no incentives for saving for retirement. While it generally retains the current rules for 401(k) and other retirement plans, it would repeal the rules allowable Roth IRA conversions and recharacterization of Roth IRA contributions as traditional IRA contributions.

A Tax Credit Longevity Annuity Plan, or TCLAP, would be a timely addition, and potential cornerstone, to any tax legislation. It could, and should, be passed as stand-alone legislation in the event that Congress is unable to agree on a comprehensive tax plan.

A TCLAP would have widespread appeal given its potential to create private pension plans similar to what our parents and grandparents enjoyed while also providing for long-term care benefits should this need arise. Throw in concerns about the long-term sustainability of Social Security and you’ve got the perfect storm for a TCLAP.

 

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Longevity Insurance Retirement Retirement Income Planning

Life Expectancy: Err on the Optimistic Side

You can’t do retirement income planning without considering life expectancy. Many individuals use this statistical measure as the primary factor for deciding when they will begin taking their Social Security benefits as well as for determining the duration of their retirement plan.

Life Expectancies are Averages

What many people either fail to realize or downplay is the fact that life expectancies are statistical averages based on the probability of dying at various ages. To illustrate this, let’s look at the 2014 Period Life Table that can be found on Social Security’s website. The table lists death probabilities and life expectancies for males and females at various ages ranging from 0 to 119.

Per the table, the life expectancy for a 66-year-old is 17.12 for males and 19.63 for females. This translates to an average end-of-life age 83 for males and 86 for females. In other words, 50% of males who reach age 66 are projected to die before age 83 and 50% are projected to die after 83. The same probabilities apply to females, with 50% projected to die before age 86 and 50% after 86.

Assuming that you’re a 66-year-old male in good health, why would you plan on living only 17 more years? Do you want to live out your remaining days believing that 80% of your life is behind you and you only have another 20% to go? That’s what you’re doing when you use life expectancy.

When Are We Dying?

To better understand when people are dying, I analyzed Table 3 of the Centers for Disease Control and Prevention National Center for Health Statistics National Vital Statistics Reports for 2014, the most recent year for which the report was published. The following is an excerpt from the table showing the number of males and females in various age brackets beginning at 65 – 69 who died in 2014.

                 MALE             FEMALE              TOTALS
     Age Number Percentage Number Percentage Number Percentage
65 – 69 129,802      14.5% 93,032        9.0% 222,834      11.6%
70 – 74 138,846      15.5% 109,861      10.7% 248,707      12.9%
75 – 79 149,259      16.7% 132,813      12.9% 282,072      14.7%
80 – 84 167,171      18.7% 175,261      17.0% 342,432      17.8%
85 and over 308,785      34.5% 517,441      50.3% 826,226      43.0%
Totals 893,863    100.0% 1,028,408    100.0% 1,922,271    100.0%
Total Deaths for All Ages 1,328,241 1,298,177 2,626,418  
Ages 65+ as a % of Total         67.3%         79.2%         73.2%

Per the table, 1.9 million, or 73.2% of the 2.6 million individuals who died in 2014 were 65 or older. 60.8% of this group died when they were 80 or older, with 43% dying after age 84. 1.0 million, or 79.2% of the 1.3 million females who died in 2014 were 65 or older. 67.3% of the female group died when they were 80 or older, with 50.3% dying after age 84. Males weren’t quite as fortunate. 900,000, or 67.3% of them died when they were 65 or older. 53.2% made it to 80 or older, with 34.5% surviving to 85 and over.

Planning Implications of Using Life Expectancy

The primary planning implication of using life expectancy as the basis for all of your retirement planning decisions is that there’s a 50% chance that you’re projected to outlive your assets. A recent New York Times article featured a 90-year-old woman, Alice Jacobs, who was once well off, owning a factory and horses.

As a result of years of living in an assisted living center, Alice depleted her savings and is now dependent on Medicaid to pay for her care at a county-owned nursing home in Virginia. Alice’s quote says it all, “You think you’ve got enough money to last all your life, and here I am.”

Unfortunately, Alice’s situation isn’t isolated. As the article points out, Medicaid pays for most of the 1.4 million people in nursing homes, covering 20 percent of all Americans and 40 percent of poor adults.

Given the reality of outliving one’s assets, longevity protection strategies should be considered for inclusion in every retirement income plan. Pre-retirees and retirees alike whose plans include predictable lifetime income are more confident about their ability to retire and remain retired than those who don’t.

What about Genetics?

What role does genetics play in determining how long you will live? Aren’t you destined to get the diseases that run in your family? More and more research is showing that genetic determinism, which many scientific thinkers espoused in the 19th and early 20th century, is limited in predicting and preventing disease.

A relatively new field, epigenetics, is demonstrating that environment, not genetics, is the primary factor in controlling human health and disease. In his article, “Why Your Genes Aren’t Your Destiny,” Chris Kresser makes the point that while genes have a powerful influence on our susceptibility to disease, “in most cases, genetic predispositions will only manifest in the presence of certain environmental factors.”

Epigenetics has demonstrated that genes don’t control themselves. In his article, “Why Your DNA Isn’t Your Destiny,” Dr. Mercola states that we change our genetics from the foods we eat, the air we breathe, and even the thoughts we think. According to Dr. Mercola, epigentics helps explain why one identical twin develops cancer and the other remains healthy and why one becomes obese and the other remains lean.

Plan for a Long Life

Life expectancy, which is nothing more than a statistical average based on the probability of dying at a particular age, can be used as a starting point when doing retirement planning. Given the fact, however, that a high percentage of individuals who live to 65 survive to 80 and over, it behooves you to plan for a long life assuming that you’re in good health or you have the ability to take control of, and are motivated to improve, your health.

Being optimistic about, and planning for, a long life is good for your physical, mental, and financial health. When it comes to life expectancy, err on the optimistic side.

Categories
Annuities Deferred Income Annuities Longevity Insurance Qualified Longevity Annuity Contract (QLAC)

Don’t Defer Your QLAC Purchase

Conceptual composition presenting money concern, pliers holds a hundred euro banknote with lifetime title on it.

I was recently asked by CNBC personal finance writer Tom Anderson, who was writing a story on qualified longevity annuity contracts, or QLACs, “What are the biggest mistakes clients make when buying QLACs?” My answer, which was quoted in Tom’s September 9th An Option for Those Who Fear Outliving Their Money article, was not purchasing a QLAC soon enough.

A Special Type of Annuity

QLACs are a special type of deferred income annuity, or DIA, that was approved by IRS in July, 2014. There are four things that distinguish QLACs from DIAs:

  • They can only be held in traditional IRA and retirement plan accounts.
  • They circumvent IRS’ required minimum distribution, or RMD, rules mandating annual age-based withdrawals beginning at age 70-1/2.
  • Lifetime distributions must begin at a specified date no later than age 85.
  • Purchase amount is limited to the lesser of $125,000 or 25% of combined traditional IRA and retirement plan values.

QLACs Aren’t for Everyone

QLACs aren’t for everyone. This is reflected in my quote, “The biggest mistake a client can make when buying a QLAC, assuming the client doesn’t need the income before 75 or so, is not purchasing a QLAC soon enough.”

If you anticipate that you can’t afford to postpone the start date for receiving income from a portion of your retirement plans until 75 or later, then a QLAC doesn’t make sense. You can still purchase a DIA in your traditional IRA or retirement plan, however, your income must begin by age 70-1/2.

Four Decisions

If you would like to carve out a portion of your traditional IRA and retirement plans in exchange for a deferred lifetime income stream, in addition to choosing beneficiaries and the life insurance company from which you will purchase your QLAC, there are four decisions you need to make:

  1. Subject to the investment limitation of the lesser of $125,000 or 25% of traditional IRA and retirement plan values, how much do you want to invest?
  2. Subject to the maximum deferral age of 85, when do you want to begin receiving income?
  3. Which pre- and post-income payout options should you choose, e.g., return of premium (pre-income payout option), life only, life with cash refund, 10-year certain, etc.?
  4. When should you invest?

Purchase Sooner Than Later

What is obvious to most people is the longer you defer your income start date, the greater the amount of your monthly lifetime income. If you begin receiving income at age 85 vs. 75, the insurance company will increase your monthly income significantly since they will be making payments to you for ten less years.

Something that’s not necessarily intuitive for a lot of people is the fact that your monthly payout will also increase if you purchase your QLAC sooner than later.  There’s no minimum purchase age limitation for QLACs.

As an example, assuming that you want your income payout to begin at age 80, your annual payout as a percentage of your investment will be 15% if you purchase at age 70 and will increase to 25% if you do so instead at age 60 with one of the QLACs available from a highly-rated carrier.  Assuming an investment of $125,000, this translates to annual income of approximately $19,000 if you purchase at age 70 vs. $31,000, or $12,000 more, if you do so at age 60.

Subject to availability in individual retirement plans, I would encourage most people who are at least 45 years old and have at least $500,000 in traditional IRAs and retirement plans to transfer $125,000 into a QLAC in order to secure a sustainable lifetime income stream, remove this amount from future stock market volatility, and maximize payout. Additional purchases can be made if IRS increases the QLAC investment limitation.

There’s an important caveat to keep in mind.  Even though your income payment will be slightly less, you should always purchase a QLAC with a pre-income commencement death benefit, or “return of premium” feature. Assuming this is part of your QLAC and you and your spouse, if married, both die before your income start date, your beneficiaries will receive a death benefit equal to your purchase, or premium, amount.

As I was also quoted in the CNBC article, “They (QLACs) will increase in popularity as more carriers offer them. I believe that higher net worth individuals with large IRA balances will gravitate toward them if the current investment limitation of $125,000 is meaningfully increased.”

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Annuities Deferred Income Annuities Longevity Insurance Qualified Longevity Annuity Contract (QLAC)

QLACs are Here

Since the Treasury and IRS finalized a regulation in the beginning of July blessing the use of qualified longevity annuity contracts, or “QLAC’s,” a lot of people have been wondering when and where they can buy one. Per the last paragraph of my September 15th “Don’t Expect to See QLAC’s Soon” post, speculation was that product launch may begin in the fourth quarter of this year.

The mystery is now behind us. The first QLAC to hit the market was recently released by AIG through American General Life Insurance Co with its American Pathway deferred income annuity. AIG enjoys overall high ratings from independent ratings agencies, including A+, or strong, ratings from Standard & Poor’s and Fitch Ratings, A, or excellent, from A.M. Best Company, and A2, or good, from Moody’s Investors Service.

What’s Different about QLACs?

Subject to their current investment limitation of the lesser of $125,000 or 25% of one’s retirement plan balance, QLACs offer two distinct advantages over other investment vehicles for meeting part of a retiree’s income needs as follows:

  1. A portion of retirement assets exposed to stock market declines can be exchanged for a predictable sustainable lifetime income stream beginning at a specific date up to age 85.
  2. Can defer income taxation of a portion of retirement plan balances for up to 15 years with its exemption from the required minimum distribution, or “RMD,” rules, that otherwise require taking minimum distributions from retirement plans beginning by April 1st of the year following the year that you turn 70-1/2.

Predictable Sustainable Lifetime Income Stream

QLACs are a special type of deferred income annuity, or “DIA.” A DIA is an annuity from which annuitization begins at least 12 months after the date of purchase in exchange for a lump sum or series of periodic payments. The annuitization can be for a term certain or lifetime, depending upon the terms of the annuity contract.

Fixed income annuities, including lifetime DIAs, have previously been allowed to be included in retirement plans provided that payments (a) begin by April 1st of the year following the year that the owner turns 70-1/2 and (b) are structured so that they will be completed distributed over the life expectancies of the owner and the owner’s beneficiary.

QLACs extend the potential income start date of retirement plan assets allocated to them to age 85. In addition to predictable sustainable lifetime income, this enables individuals who have other sources of income to increase the amount of annual income that they will eventually receive from QLAC investments compared to non-QLAC DIAs held in retirement asset accounts.

Circumvent RMD Rules for a Portion of Retirement Plan Assets

Other than converting retirement plan assets to Roth IRAs which often triggers income tax liability at the time of conversion, there has been no other game in town for avoiding the RMD rules prior to QLAC’s. QLAC’s offer an opportunity to defer taxation on up to the lesser of $125,000 or 25% of one’s retirement plan balance at the time of investment.

Depending upon the timing of the QLAC investment and the income start date, the reduction in RMDs and potential income tax savings can be significant. Suppose that you’re 50 and your traditional IRA, which is your only retirement plan, has a value of $600,000. Let’s further assume that you invest $125,000 of your IRA in a QLAC with an income start date of 80.

Had you not invested $125,000 in a QLAC, assuming a 4% rate of return, this portion of your IRA would grow to $273,890 when you turn 70. The first year RMD for this value would be just under $10,000. The income tax savings from not withdrawing this amount of income from your IRA and potential greater amounts for the next ten years could be significant.

QLAC Market

With the release of AIG’s QLAC, the cat is out of the bag. Other insurance carriers are either in the process, or will soon be, requesting regulatory approval for their QLAC offerings. Per my September 15th post, it was, and still is, my personal opinion that widespread availability will not occur until well into 2015. Once this happens and consumers understand and appreciate the two distinct advantages that QLACs offer over other investment vehicles for meeting part of a retiree’s income needs, I believe that demand for this unique product will increase significantly.

Categories
Deferred Income Annuities Longevity Insurance Qualified Longevity Annuity Contract (QLAC) Retirement Income Planning

Don’t Expect to See QLAC’s Soon

One of the most exciting retirement income planning opportunities since the elimination of the Roth IRA conversion income threshold in 2010 has been approved, however, it isn’t available yet for purchase.

For those of you who may not be familiar with the change in Roth IRA conversion eligibility rules, prior to 2010, only taxpayers with modified adjusted gross income of less than $100,000 were eligible to convert a traditional IRA to a Roth IRA. With the elimination of the income threshold, Roth IRA conversions have soared in popularity since anyone may convert part, or all, of his/her traditional IRA to a Roth IRA. See Year of the Conversion to learn more.

The most recent potential retirement income planning game-changer, qualified longevity annuity contracts, or “QLAC’s,” have received a fair amount of press since the Treasury and IRS finalized a regulation in the beginning of July blessing their use. I have personally written two other articles about them, beginning with 6 Ways a New Tax Law Benefits a Sustainable Retirement published July 25th in the RetireMentors section of MarketWatch and my August 4th Retirement Income Visions™ blog post, You Don’t Have to Wait Until 85 to Receive Your Annuity Payments.

What are QLAC’s?

QLAC’s came about in response to increasing life expectancies and the associated fear of outliving one’s assets. With the passage of IRS’ final regulation, retirement plan participants can now invest up to the lesser of $125,000 or 25% of their retirement plan balance in specially-designated deferred income annuities, or “DIA’s,” that provide that lifetime distributions begin at a specified date no later than age 85. Unlike single premium immediate annuities, or “SPIA’s,” that begin distributing their income immediately after investment, the start date for DIA income payments is deferred for at least 12 months after the date of purchase.

As discussed in my July 25th MarketWatch article, QLAC’s offer a new planning opportunity to longevitize your retirement in six different ways. While longevity is the driving force for QLAC’s, the income tax planning angle, which is the first possibility, has been attracting the lion’s share of media attention. Specifically, QLAC’s provide retirement plan participants with the ability to circumvent the required minimum distribution, or “RMD,” rules for a portion of their retirement plan assets. These rules require individuals to take annual minimum distributions from their retirement plans beginning by April 1st of the year following the year that they turn 70-1/2.

Where Do I Buy a QLAC?

I’ve had several people ask me recently, “Where do I buy a QLAC?” Unlike the Roth IRA conversion opportunity that expanded the availability of an existing planning strategy from a limited audience to anyone who owns a traditional IRA with the elimination of the $100,000 income barrier beginning on a specified date, i.e., January 1, 2010, the implementation of IRS’ QLAC regulation is much more complicated. This is resulting in an unknown introduction date for QLAC offerings.

There are several reasons for this, not the least of which is the nature of the product itself. First and foremost, although an existing product, i.e., a deferred income annuity, or “DIA,” will initially be used as the funding mechanism for QLAC’s, the contracts for DIA’s that are currently available don’t necessarily comply with all of the various provisions of IRS’ new QLAC regulation. While the three mentioned are the most important, i.e., (1) Only available for use in retirement plans, (2) limitation of lesser of $125,000 or 25% of retirement plan balance, and (3) distributions must begin at a specified date no later than age 85, there are other technical requirements that must be met in order for a DIA to be marketed and sold as a QLAC.

In addition to understanding and complying with the nuances of the IRS regulation, life insurance carriers that want to offer QLAC’s are scrambling to restructure existing DIA products and develop new products that will (a) match consumers’ needs, (b) be competitive, and (c) meet profit objectives. This requires a host of system and other internal changes, state insurance department approvals, and coordination with distribution channels, all of which must occur before life insurance companies will receive their first premiums from sales of this product.

Another important obstacle to the introduction of QLAC’s is the fact that fixed income annuities with deferred income start dates, including DIA’s and fixed index annuities, or “FIA’s,” with income riders, are a relatively new product to which many consumers haven’t been exposed. While both products are designed, and are suitable, for use in retirement income plans, most investment advisors don’t currently have the specialized education, licensing, and experience to understand, let alone offer, these solutions to their clients. See What Tools Does Your Financial Advisor Have in His or Her Toolbox?

So when will you be able to purchase QLAC’s? Although current speculation is that product launch may begin in the fourth quarter of this year, it’s my personal opinion that widespread availability will not occur until well into 2015. This will give investment advisers and consumers, alike, additional time to get more educated about fixed income annuities, including their place in retirement income plans. Once the word spreads, I believe that the demand for fixed income annuities will increase significantly, especially if the timing is preceded by a stock market decline.

Categories
Annuities Deferred Income Annuities Fixed Index Annuities Longevity Insurance

Longevity Insurance is an App

App: A self-contained program or piece of software designed to fulfill a particular purpose (Google Definition). A smartphone would be nothing more than a paperweight if it didn’t have any apps. The most basic function of a smartphone, i.e., making and receiving phone calls, wouldn’t be possible without a phone app.

Apps are the lifeblood of a smartphone. Mobile phone and data plans generate billions of dollars of revenue each year for wireless communications companies. The phone, itself, is secondary, and, as such, is typically heavily discounted when phone and data plans are purchased.

An analogy can be made to longevity insurance. Many, if not most, people are under the mistaken belief that when they purchase longevity insurance, they’re buying a product (i.e., smartphone) whose sole purpose is to provide them with lifetime income beginning at age 85 in the event that they live to a ripe old age.

Let’s dispel two myths. First of all, there’s technically no such thing as a longevity insurance product. You won’t receive a “longevity insurance” contract from an insurance company. When you buy longevity insurance, you’re buying an app. In order to use the app, you will need to purchase either a deferred income annuity (“DIA”) or a fixed index annuity (“FIA”) with an income rider, with DIA’s being favored as the traditional longevity insurance product.

DIA’s and FIA’s with income riders are both fixed income annuities that provide the ability to (a) receive income beginning in a future year, and (b) have the income be paid for the remainder of one’s life and a spouse’s life if married. The main difference between DIA’s and FIA’s when it comes to lifetime income is the start date. With a DIA, there’s a fixed start date that’s contractually defined. FIA’s with income riders have a flexible income start date that can typically begin one year after purchase or at any time thereafter during the life of the contract.

Second, unless you purchase a DIA and choose it at the time of application, lifetime income doesn’t have to begin at age 85. There’s no fixed income starting date associated with longevity insurance. You can purchase a DIA that pays lifetime income beginning at age 75. In addition, you can purchase a term DIA where income is paid for a fixed number of months or years. As an example, income could begin at age 82 and end at age 87. Furthermore, as previously explained, if you purchase a FIA with an income rider, other than stating the earliest possible income start date, a FIA contract doesn’t require you to begin taking withdrawals on a specific date.

Although DIA’s and FIA’s with income riders may be purchased to provide what’s marketed as longevity insurance, this is only one application of both products. What is thought of as longevity insurance, i.e., lifetime income beginning at age 85, accounts for a small portion of fixed income annuity product sales. While a later starting date generally will result in a greater amount of lifetime income, all else being equal, most retirees need to begin taking income distributions to cover expenses at an earlier age.

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Annuities Deferred Income Annuities Fixed Index Annuities Longevity Insurance Retirement Income Planning

Insure Your Longevity

When people hear the term, “longevity insurance,” they immediately conjure up images of insurance agents trying to sell them an insurance policy. Longevity insurance isn’t a product in and of itself. It is instead one application of a couple of different types of fixed income annuity products offered by life insurance companies.

The Need for Longevity Insurance

It’s been my personal and professional experience that people generally underestimate how long they will live. Not only is it common to live to age 80, it isn’t unusual to survive to age 90 and even to 100. According to a March, 2012 report, The 2011 Risks and Process of Retirement Survey, prepared for the Society of Actuaries, when a couple reaches 65, there’s a 10% chance that at least one of the individuals will live to 100. There’s a 1% chance that one spouse will reach 107. More than half of retirees and pre-retirees underestimate the age to which a person of his or her age and gender can expect to live.

Given the foregoing facts, combined with the uncertainty of the sustainability of a traditional investment portfolio as a source of retirement income, there’s a need for a guaranteed lifetime income solution for the latter stage of one’s life. The income amount, when combined with other sources of sustainable income, needs to be sufficient to meet projected known and unforeseen expenses for an indefinite period of time.

Products Providing Longevity Insurance

There are two types of fixed income annuities that can be used for the purpose of longevity insurance: deferred income annuities (“DIA’s”) and fixed index annuities (“FIA’s”) with income riders. Both provide the ability to (a) receive income beginning in a future year, and (b) have the income be paid for the remainder of one’s life and a spouse’s life if married.

Deferred Income Annuities

Although DIA’s are currently offered by only a handful of life insurance companies, they’re the solution that’s typically been touted for longevity insurance up until now. Like single premium immediate annuities, or “SPIA’s,” DIA’s pay periodic income for a specified period of time or over one’s lifetime or joint lifetimes as applicable. Unlike SPIA’s which begin payments one month after date of purchase, the start date of DIA payments is contractually defined and is deferred for at least 13 months. The longer the income start date is delayed, the lower the premium, or investment, required to provide a specified amount of income.

Although DIA’s can be purchased for a specified term, e.g., ten years, when used as longevity insurance, the payout on DIA’s often starts in one’s 80’s and is for life. Depending upon the age at which a DIA is purchased, the premium can be a relatively small amount compared to the potential lifetime income that may be received.

Fixed Index Annuities With Income Riders

For those individuals who don’t want to be locked into a fixed starting date, in addition to providing an accumulation value, FIA’s with income riders offer greater flexibility than DIA’s. With FIA’s, which are more readily available than DIA’s, there’s no contractual income start date. Income withdrawals can generally begin any time at least one year after the initial investment is made. The longer the start date is deferred, the greater the amount of lifetime income. The start date can be targeted when the investment is purchased based on the amount and timing of initial and projected ongoing investments and desired amount of income. A flexible, vs. single, premium FIA is required in order to invest additional funds.

Depending upon one’s needs and marketplace availability, it may make sense to use a combination of DIA’s and FIA’s with income riders. and potentially multiple products within each category, to meet deferred lifetime income needs. As with all things of this nature, a thorough analysis should be prepared by a professional retirement income planner to determine the solution that will best meet your needs.

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Long-Term Care Longevity Insurance

The Retirement Income Planning Sweet Spot

Retirement Income Center

If you know me professionally, you know that I’m big on distinguishing between retirement income, vs. retirement asset, planning. This isn’t about semantics. It’s about being practical. Unless your lifestyle allows you to survive solely on Social Security or a comparable monthly benefit if you don’t qualify for Social Security, you need to create your own pension. This is, after all, the theme of this blog: Innovative strategies for creating and optimizing retirement income.

In order to create your own pension, you need assets. The question is, when should you transition from a retirement asset planning to a retirement income planning approach? Tied into this question is a related question: Is your current financial advisor trained, experienced, and equipped to offer solutions to assist you with making this change? If not, it may be time to look for a new adviser who specializes in retirement income planning.

See What Tools Does Your Financial Advisor Have in His or Her Toolbox

So when should you begin creating your own pension? This is a daunting task since the primary goal is to ensure that you won’t outlive your income while surrounded by many unknowns, including, how long you will live, potential health issues and timing and cost of same, as well as changing inflation and tax rates, to name a few. Given this situation, there ideally needs to be a significant amount of lead time to do the necessary planning.

As with all financial planning goals, you need to work backwards from your target date. By definition, the applicable date for retirement income planning would be the age at which you would like to retire. Given the complexity of the process together with the many unknowns, a 20-year lead time is generally advised. Assuming that you would like to retire at age 70, you should have an initial retirement income plan prepared at age 50.

This doesn’t mean that you need to transfer all of your nonretirement and retirement investment assets into income-producing assets on your 50th birthday. This is simply when the transition from a retirement asset planning to a retirement income planning process should begin. Strategies will generally be implemented gradually over the course of the years leading up to, as well as after, retirement as your situation changes and different opportunities present themselves. Your retirement income plan needs to be vibrant, proactive, and responsive to change since you will experience many of them at an increasing rate as you approach, and move into, your retirement years.

In addition to retirement income planning strategies, your plan should include income protection strategies for yourself and for your spouse if married. An unprotected, or under protected, life event such as disability, long-term care, or death can severely reduce the longevity of, and potentially prematurely deplete, your, or your survivor’s, investment assets. Income protection strategies should be included and implemented as part of an initial retirement income plan due to the fact that they become increasingly expensive and potentially cost prohibitive with age, not to mention the risk of being uninsurable as you get older.

So what if you’re within 20 years of retirement and you haven’t begun retirement income planning? No need to panic. While your strategies and potential opportunities may be more limited depending upon how close to retirement you are, it’s never too late to start a retirement income plan. As previously stated, retirement income planning strategies are generally implemented both before and during retirement as your situation changes and different opportunities present themselves.

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Annuities Deferred Income Annuities Fixed Index Annuities Longevity Insurance

Invest in DIA to Fund LTCI Premiums When Retired – Part 2 of 4

Last week’s post discussed the use of a deferred income annuity (“DIA”), commonly referred to as longevity insurance, to fund long-term care insurance (“LTCI”) premiums during retirement. Similar to a fixed index annuity (“FIA”) with an income rider, in exchange for an initial investment, or premium, you’re entitled to receive a lifetime income beginning at least a year from the date of purchase.

As noted in last week’s post, there are five important differences between FIA’s with income riders and DIA’s that will influence which retirement income planning strategy is preferable for funding LTCI premiums in a given situation. These differences are as follows:

  1. Income start date flexibility
  2. Income increase provision
  3. Income tax consequences
  4. Investment value
  5. Death benefit

The first three distinctions are explained below. Part three will discuss the fourth and fifth differences. Part four will present a sample case to illustrate the use of a DIA vs. a FIA with an income rider to fund LTCI premiums during retirement.

Income Start Date Flexibility

FIA’s with income riders are known for their flexibility when it comes to their income start date. Income can typically be withdrawn beginning one year from the initial issue date with no time limit after that. The lifetime income payout will generally increase the longer you wait to begin your withdrawals as a result of potential increases in the income base and withdrawal percentages.

Unlike FIA’s, DIA’s generally aren’t flexible when it comes to the income start date. With most DIA’s, you’re tied to a specified payout at a specified start date at the time of investment.

Income Increase Provision

Although DIA’s generally have a fixed income start date, an annual inflation factor can be applied to the income payout to result in increasing annual payments. A greater premium, or investment, is required for this feature.

While the annual lifetime income payout will generally increase the longer you wait to begin your withdrawals with a FIA, the income amount generally won’t change once you turn on your income. In other words, there’s inflation protection built into FIA income riders only up until the time that you begin taking income withdrawals.

Income Tax Consequences

If retirement plans such as 401(k)’s or traditional IRA’s are the source of premium payments, then 100% of withdrawals from DIA’s and FIA’s will generally be taxable as ordinary income. Consequently, it doesn’t matter if the source of funds for LTCI premium payments is a FIA with an income rider or a DIA since taxation will be identical.

Whenever possible, nonretirement funds should be used to pay LTCI premiums. Here’s where DIA’s have the edge, especially during the early years. DIA payouts are considered to be an annuitization of the investment. Part of each payment through one’s life expectancy is deemed to be principal and interest. Any payments received thereafter are fully taxable.

Since only the interest portion is taxable and a large part of each payment is often classified as principal over the course of one’s life expectancy, DIA distributions receive tax-favored treatment.

When you take income withdrawals from FIA’s, on the other hand, you aren’t annuitizing your investment. Instead, “last-in first-out,” or “LIFO,” taxation is applied to your withdrawals. This means that 100% of your initial withdrawals will be taxed until all interest is recovered with subsequent withdrawals received tax-free as a return of principal.

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Annuities Deferred Income Annuities Fixed Index Annuities Long-Term Care Longevity Insurance

Invest in DIA to Fund LTCI Premiums When Retired – Part 1 of 4

As explained in the last two weeks’ posts, Invest in FIA to Fund LTCI Premiums When Retired – Parts 1 and 2, the purchase of long-term care insurance (“LTCI”) needs to be a lifetime commitment. It isn’t enough to plan for how you will pay for your LTCI premiums during your working years. Planning for the potential purchase of a LTCI policy should be included as part of the retirement income planning process to determine the sources of income that will be used to pay for LTCI throughout retirement.

One potential source of income that can be used to fund LTCI premiums during retirement is a fixed index annuity (“FIA”) with an income rider. As explained and illustrated in the last two weeks’ posts, with a FIA, you can determine the initial and ongoing investment amounts required to produce a targeted amount of income to match your LTCI premiums, including projected increases in same.

Another strategy that can be used for this purpose is to purchase a deferred income annuity (“DIA”), commonly referred to as longevity insurance. Similar to a FIA with an income rider, in exchange for an initial investment, or premium, you’re entitled to receive a lifetime income beginning at least a year from the date of purchase. You can invest a specified amount in a DIA that will result in the amount of lifetime income beginning at retirement that will be sufficient to pay your LTCI premiums.

There are several important differences between FIA’s with income riders and DIA’s that will influence which retirement income planning strategy is preferable for funding LTCI premiums in a given situation. There are five key distinctions that need to be considered as follows:

  1. Income start date flexibility
  2. Income increase provision
  3. Income tax consequences
  4. Investment value
  5. Death benefit

The first three distinctions will be explained in next week’s post. Part three will discuss the fourth and fifth differences. Part four will present a sample case to illustrate the use of a DIA vs. a FIA with an income rider to fund LTCI premiums during retirement.