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:
- 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?
- Subject to the maximum deferral age of 85, when do you want to begin receiving income?
- 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.?
- 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.”
