Tag: deferred income annuity

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Annuities Deferred Income Annuities Fixed Index Annuities Retirement Income Planning

Looking for a Deferred Fixed Income Annuity on Steroids?

Deferred income annuities (DIAs) have been getting a lot of attention since the Treasury and IRS finalized a regulation in July, 2014 blessing the use of qualified longevity annuity contracts, or “QLACs.” A QLAC is a DIA that’s held in a qualified retirement plan such as a traditional IRA with a lifetime income start date that can begin up to age 85. It’s subject to an investment limitation of the lesser of $125,000 or 25% of one’s retirement plan balance.

Fixed Income Annuity Hierarchy

For individuals concerned about longevity who are looking for a sustainable source of income they can’t outlive, fixed income annuities are an appropriate solution for a portion of a retirement income plan. There are three types to choose from:

  1. Immediate annuities
  2. Deferred income annuities (DIAs)
  3. Fixed index annuities (FIAs) with income riders

The overriding goal when choosing fixed income annuities is to match after-tax income payouts to periodic amounts needed to pay for specified projected expenses using the least amount of funds. Immediate annuities, with a payout that begins one month after purchase date, are appropriate for individuals on the cusp of retirement or who are already retired. DIAs and FIAs with income riders, with their built-in deferred income start dates, are suitable whenever income can be deferred for at least five years, preferably longer.

Assuming there isn’t an immediate need for income, a deferred income strategy is generally the way to go when it comes to fixed income annuities. This includes one or more DIAs or FIAs with income riders. Which should you choose?

DIA Considerations

As a general rule, DIAs and FIAs are both qualified to fulfill the overriding income/expense matching goal. Both offer lifetime income payouts. If your objective is deferred lifetime sustainable income, DIA and FIA with income rider illustrations should be prepared to provide you with an opportunity to compare income payouts.

DIAs can also be purchased for a specified term of months or years. This can be important when there are projected spikes in expenses for a limited period of time.

DIAs may also be favored when used in a nonretirement account since a portion of their income is treated as a nontaxable return of principal. Finally, if you’re looking to defer the income start date beyond the mandatory age of 70-1/2 for a limited portion of a traditional IRA, a QLAC, which is a specialized DIA, may be an appropriate solution.

Let’s suppose that you’re a number of years away from retirement and you’re not sure when you want to retire or how much income you will need each year. A DIA may not be your best choice since you lock in a specified income start date and income payout at the time of investment with most DIAs.

FIA with Income Rider Features

FIAs with income riders hold a distinct advantage over DIAs when it comes to income start date flexibility. Unlike a DIA, there’s no requirement to specify the date that you will begin receiving income when you purchase a FIA.

The longer you hold off on taking income, the larger the periodic payment you will receive. Furthermore, there’s no stipulation that you ever need to take income withdrawals. This is ideal when planning for retirement income needs ten or more years down the road.

For individuals not comfortable with exchanging a lump sum for the promise of a future income stream beginning at a specified date, i.e., a DIA, a FIA with its defined accumulation value and death benefit, offers an attractive alternative assuming similar income payouts. While an optional death benefit feature can be purchased with a DIA to provide a return of premium to one or more beneficiaries prior to the income start date, this will reduce the ongoing income payout amount.

A FIA also has a defined investment, or accumulation, value that equates to a death benefit. Unlike with most DIAs, flexible-premium FIAs offer the ability to make additional investments that will increase income withdrawal amounts in addition to the investment value.

Some FIAs offer a premium bonus that matches a limited percentage, e.g., 5%, of your initial, as well as subsequent, investments for a specified period of time. The accumulation value is also increased by contractually-defined periodic interest credits tied to the performance of selected stock indices.

Finally, a FIA’s accumulation value is reduced by withdrawals and surrender and income rider charges. Any remaining accumulation value is paid to beneficiaries upon the death of the owner(s).

Summary

A comprehensive retirement income plan is a prerequisite for determining the type(s), investment and income payout timing, and investment amounts of fixed income annuities to match after-tax income payouts with projected expense needs assuming that longevity is a concern. If you don’t have an immediate need for income and your objective is lifetime sustainable income, DIA and FIA with income rider illustrations should be prepared to provide you with an opportunity to compare potential income payouts.

With their ability to match a spike in expenses for a limited period of time, term DIAs offer a unique solution. When it comes to lifetime income payouts, FIAs with income riders, with their flexible income start date and accumulation value and associated built-in death benefit, are, in effect, a DIA on steroids.

Given the foregoing advantages and assuming similar income payouts, FIAs with income riders generally offer a more comprehensive solution for fulfilling sustainable lifetime income needs, with the possibility of a larger death benefit. A potential exception would be when investing in a nonretirement account for higher tax bracket individuals subject to one’s preference for a flexible income start date and accumulation value/death benefit in a particular situation.

Last, but not least, all proposed annuity solutions should be subjected to a thorough due diligence review and analysis of individual life insurance companies and products before purchasing any annuity contracts.

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Annuities Deferred Income Annuities Fixed Index Annuities Retirement Income Planning

Make Sustainable Income a Cornerstone of Your Portfolio Beginning at 45

Dollar bills falling in or flying out of a pink piggy bank in a fantasy landscape

A common theme I hear when I talk to retirees is “I wish I would have started saving sooner for retirement.”

There’s an underlying feeling of guilt that’s expressed each time this statement is uttered. The implication is that the individual had the ability to save more for retirement but chose not to do so.

While it’s ultimately the responsibility of each of us to make sure that we have sufficient funds to pay for our needs for the duration of retirement, it’s extremely difficult, if not impossible in many cases, to achieve this goal without proper guidance. Saving for retirement requires a totally different mindset than saving for any other financial goal.

It’s All about Income Replacement

Most financial goals require planning for the availability of a lump sum at a future date that will either be spent (a) one time, e.g., a down payment on a house or (b) over a specified number of years, e.g., college education. Retirement, on the other hand, typically requires you to replace one source of income, i.e., salary, or draw in the case of self-employed individuals, with multiple sources of income. Furthermore, the replacement income sources must be sustainable for the duration of retirement which is unknown.

You need to use the right tools for the job at hand if you want to achieve a successful result. Retirement is no exception. Given the fact that sustainable income is the name of the game, it makes sense that investments that are allocated for retirement are designed to provide you with a targeted amount of after-tax income that will meet your needs after other sources of sustainable income, e.g., Social Security, are taken into consideration.

Timing is Key

Fixed income annuities are well-suited for this purpose since they’re designed to provide sustainable income for the duration of retirement. Deferred fixed income annuities, including fixed index annuities (FIAs) with income riders and deferred income annuities (DIAs) make the most sense due to the fact that they require the least amount of funds to generate future known income amounts compared to other types of investments.

Even though FIAs with income riders and DIAs allow you to minimize initial and ongoing investment amounts compared to other types of investments, the potential length of retirement requires you to start early if you want to generate enough income to meet your needs.

You simply can’t begin saving a relatively small portion of your salary ten years before you plan to retire and expect your savings to provide you with adequate retirement income for 25 or more years. Age 45 isn’t too early to start in most cases.

FIAs with Income Riders vs. DIAs

If you establish a sustainable income plan before age 55, I generally recommend investing in one or more FIAs with income riders vs. DIAs to provide you with the most flexibility. For starters, unlike DIAs which generally have fixed income start dates, FIAs don’t require you to begin income withdrawals at a specified date. This is a distinct advantage when you don’t know if you’re going to retire at 60, 65, or 70 and you don’t necessarily know all of your potential sources, timing, and amounts of other retirement income.

Additional funds can periodically be added to flexible premium FIAs that generally isn’t possible with DIAs. Care must be taken, however, when researching these types of FIAs since some limit the number of years that additional premiums can be added or subsequent purchase amounts. See How Flexible are Flexible Premium Deferred Annuities?

Another benefit of FIAs is their accumulation value which can increase over time and provide a pre- and post-income withdrawal death benefit. In addition to the lack of an accumulation value, a death benefit with DIAs is generally optional and is limited to the amount of premium invested in exchange for a reduced income payout.

Finally, in addition to generating sustainable retirement income, investment in FIAs with income riders and DIAs reduces portfolio risk to the extent that funds from equity investments, e.g., stocks and equity exchange-traded and mutual funds, are used.

In conclusion, it’s not only about minimizing regrets regarding how soon you started saving for retirement when you’re retired. Making sustainable income a cornerstone of your portfolio using investments that are suited for this purpose, i.e., fixed income annuities, will help you sleep better at night – before and after you retire.

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Annuities Fixed Index Annuities Retirement Income Planning

Looking for a Pension with a Flexible Start Date?

Focus on and take control of your retirement made in 2d software

If you want peace of mind when you retire, you need to have a plan that will generate sustainable income streams that will cover a large portion of your fixed and discretionary expenses. Income tax planning is critical since your income needs to be calculated net of income tax to determine the amount that will be available for spending.

A sustainable income stream is simply a regular series of payments that, once it begins, will continue for the rest of your life. An ideal sustainable income stream is one that’s calculated using life expectancy and has a flexible start date. The longer you wait to turn on your income, the greater the periodic payment.

Social Security is a great example of a sustainable income stream that meets these criteria. Although you can begin collecting as early as age 62, you can also delay your start date to as late as age 70. The longer you wait, the greater your monthly payment. Assuming a full retirement age of 67, your benefit will be 80% greater if you delay your start date from 62 to age 70, excluding cost of living adjustments.

While Social Security is an important cornerstone of most retirement income plans, it generally needs to be supplemented by other sources of sustainable income. Even if you qualify for the maximum monthly benefit of $2,663 assuming you reach full retirement age in 2015, your annual benefits of approximately $32,000 may be reduced to as little as $21,000 after income tax, depending on your other income and income tax bracket.

Fortunately, there’s another source of sustainable income beside Social Security that’s calculated using life expectancy and also features a flexible start date. It’s offered by life insurance companies and is called a fixed index annuity (FIA) with an income rider.

Unlike the start date of Social Security which is limited to a window of eight years (age 62 to 70), a FIA income rider start date is open-ended. Generally speaking, the only requirement is that you must be at least age 50 when you begin receiving income. Assuming you meet this condition, you can start your lifetime income stream at any age you choose.

Similar to Social Security, the longer you defer your start date, the greater your lifetime income payments will be. Other factors that will influence your income payment are the age at which you purchase your FIA, your original investment amount, additional investments if permitted, premium bonus when applicable, and non-income withdrawals. The calculation of your payment amount is defined by the income rider provision of your FIA’s contract.

Since the calculation of your payment amount is contractually defined, you can determine the amount of initial and ongoing investments required to provide you with a target amount of income beginning at one or more specified ages of your choice before you purchase a FIA. Furthermore, if you need different amounts of income beginning at different ages, you may want to consider investing in two or more FIAs with income riders.

In addition to meeting the criteria of an ideal sustainable income stream, i.e., one that’s calculated using life expectancy and has a flexible start date, a FIA with an income rider offers another benefit that can be important where there are potential beneficiaries. Unlike other types of fixed income annuities, i.e., immediate and deferred income annuities, a FIA has an accumulation, or cash, value.

The accumulation value increases by purchases and premium bonuses and decreases by income and non-income withdrawals and income rider and surrender charges. Any accumulation value remaining at the death of the contract owner(s) will be paid as a death benefit to the beneficiaries.

As stated at the beginning of this post, income tax planning is a critical part of the retirement income planning process since your income needs to be calculated net of income tax to determine the amount that will be available for spending. All income payments from FIAs with income riders are taxable as ordinary income. This is true whether they’re held in traditional IRAs and other types of retirement plans or as nonqualified, i.e., nonretirement, investments.

If you’re looking for a pension with a flexible start date to increase the amount of your fixed and discretionary expenses that are covered by sustainable income throughout your retirement, one or more FIAs with an income rider may meet your needs.

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Annuities Deferred Income Annuities Income Tax Planning Qualified Longevity Annuity Contract (QLAC)

Is a QLAC Right for You?

2014 marked the introduction of qualified longevity annuity contracts, or QLACs. For those of you not familiar with them, a QLAC is a deferred fixed income annuity designed for use in retirement plans such as 401(k) plans and traditional IRAs (a) that’s limited to an investment of the lesser of $125,000 or 25% of the value of a retirement plan and (b) requires that lifetime distributions begin at a specified date no later than age 85. QLAC investment options are currently limited to deferred income annuities, or DIAs.

The purchase of deferred fixed income annuities in retirement plans for longevity protection isn’t a new concept. What’s unique about QLACs is the ability to extend the start date of required minimum distributions (RMDs) from April 1st of the year following the year that you turn 70-1/2 to up to age 85. This provides potential income tax planning opportunities for QLAC holders subject to the purchase cap.

Potential Income Tax Savings

A lot of individuals are selling QLACs short due to the purchase cap. While on the surface, $125,000 may not represent a sizable portion of a retirement plan with assets of $750,000 or more, the potential lifetime income tax savings can be significant.

The amount of savings is dependent on six factors: (a) amount of QLAC investment (b) age at which QLAC investment is made, (c) deferral period from date of QLAC purchase until income start date, (d) rate of return, (e) income tax bracket, and (f) longevity.

Illustration

I have prepared the attached exhibit to illustrate potential income tax savings achievable by investing $125,000 at three different ages in a QLAC by comparing it to a non-QLAC investment that’s subject to the RMD rules. Assumptions used in the preparation of the exhibit are as follows:

  1. $125,000 is invested in a non-QLAC vehicle at one of three different ages: 55, 60, or 65.
  2. Rate of return is 5%.
  3. RMD’s are taken from age 71 through 85, the range of ages between which RMD’s and QLAC distributions, respectively, are required to begin.
  4. Income tax brackets are 2015 federal income tax brackets plus 5% for assumed state income tax.

In addition to assumed rates of return and income tax brackets, a key assumption is the age at which the QLAC investment is made. All else being equal, purchases at earlier ages avoid greater amounts of RMDs and associated income tax liability. Per the exhibit, the amount of projected income tax savings over 15 years ranges from approximately $20,000 to $97,000 depending upon assumed QLAC investment date and income tax bracket.

Considerations

Reduction of RMDs and associated income tax liability is an important goal, however, it may not be the best strategy for achieving the overriding goal of retirement income planning, i.e., making sure that you have sufficient income to meet your projected expenses for the duration of your retirement.

There are several questions you need to answer to determine the amount, if any, that you should invest in a QLAC:

  • What are your projected federal and state income tax brackets between age 71 and 85?
  • What are the projected rates of return on your retirement funds between 71 and 85 taking into consideration the likelihood of at least one bear market during this time?
  • What is your, and your spouse, if married, projected life expectancy?
  • Which years between age 71 and 85 can you afford to forego receipt of projected net RMD income, i.e., RMD less associated income tax liability?
  • Will you need to take retirement plan distributions in excess of your RMDs, and, if so, in which years and in what amounts?
  • What other sources of income do you have to replace the projected RMD income you won’t be receiving?
  • What is the projected income tax liability you will incur from withdrawing funds from other sources of income?
  • What is the amount of annual lifetime income that you will receive from a QLAC beginning at various ages between 71 and 85 assuming various investment amounts, with and without a death benefit with various payout options?
  • Does it make more sense to invest in a non-QLAC longevity annuity such as a fixed index annuity with an income rider?
  • Should you do a Roth IRA conversion instead?

Given the fact that opportunities to reduce RMDs and associated income tax liability are limited, QLACs are an attractive alternative. Projected income tax savings are just one factor to consider and can vary significantly from situation to situation, depending upon assumptions used. There are a number of other considerations that need to be analyzed before purchasing a QLAC to determine the best strategies for optimizing your retirement income.

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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.

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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

You Don’t Have to Wait Until 85 to Receive Your Annuity Payments

Longevity insurance was recently blessed again by the IRS with its finalization of a regulation allowing the inclusion of an advanced-age lifetime-income option in retirement plans such as 401(k) plans and IRAs.

As discussed in my July 25 MarketWatch article, 6 Ways a New Tax Law Benefits a Sustainable Retirement, “longevity insurance” isn’t an actual product that you can purchase from a life insurance carrier. It’s instead a term that refers to a deferred lifetime fixed income annuity with an advanced age start date, typically 80 to 85.

In a nutshell, IRS’ final regulation allows you to invest up to the lesser of $125,000 or 25% of your retirement plan balance in “qualifying longevity annuity contracts” (QLACs) provided that lifetime distributions begin at a specified date no later than age 85. Although the regulation leaves the door open for other types of fixed-income annuities in the future, QLAC investment vehicles are currently limited to lifetime deferred income annuities, or DIAs.

Suppose you’re concerned about the possibility of outliving your assets and you’re considering investing a portion of your retirement plan in a QLAC. Do you have to wait until age 85 to begin receiving your lifetime annuity payments? Absolutely not. So long as distributions begin no later than the first day of the month following the attainment of age 85, you will be in compliance with the regulation.

Although the regulation doesn’t define the earliest starting date of QLAC payments, based on previous legislation, it would seem to be April 2 of the year following the year that you turn 70-1/2. Why April 2? Per my MarketWatch article, regulations in effect before the new rule allow for inclusion of fixed income annuities without limit provided that the periodic annuity payments (a) begin by April 1 of the year following the year that the owner turns 70-1/2 and (b) are structured so that they will be completely distributed over the life expectancies of the owner and the owner’s beneficiary in compliance with IRS’ required minimum distribution, or RMD, rules.

Let’s suppose that you’re doing retirement income planning when you’re 60 and you’re planning on retiring at 67. In addition to your IRA which has a value of $600,000, you have a sizeable nonretirement portfolio that will not only enable you to defer your Social Security start date to age 70, there’s a high likelihood that you won’t need to withdraw from your IRA until 75.

Despite the fact that you don’t foresee needing income from your IRA until 75, IRS requires you to begin taking minimum annual distributions from your IRA beginning by April 1 of the year following the year that you turn 70-1/2. This is true, however, IRS now also allows you to circumvent the RMD rules by investing a portion of your retirement plan assets in a QLAC. Relying on these rules, you decide to invest $125,000 of your IRA in a QLAC with an income start date of 75. This enables you to longevitize, or extend the financial life of, your retirement using the six ways described in my MarketWatch article.

As you can see, there’s a lot of flexibility when it comes to selecting the start date of your lifetime income distributions from a QLAC. There’s approximately a 13- to 14-year window depending upon your birth date which falls between April 2 of the year following the year that you turn 70-1/2 and age 85. The key is that you must define your income start date at the time of applying for your QLAC. This is a requirement of all deferred income annuities, not just QLAC’s.

Finally, a QLAC may, but is not required to, offer an option to begin payments before the contract’s annuity starting date. While the amount of your periodic distributions will be greater the longer you defer your start date, you don’t have to wait until age 85 to begin receiving lifetime income.

Categories
Annuities Deferred Income Annuities Retirement Income Planning

Consider a Death Benefit When Buying Deferred Income Annuities

If you’re in the market for sustainable lifetime income, you’ve come to the right place if you’re looking at fixed income annuities. A fixed income annuity is a fixed (vs. variable) annuity that provides income payments for your lifetime or for a contractually-defined term.

There are three types of fixed income annuities, each one serving a different purpose in a retirement income plan. The three types are as follows:

The main distinction between the three types of fixed income annuities is the timing of the commencement of income payments. As its name implies, the income from a SPIA begins immediately. The actual start date is one month after the date of purchase assuming a monthly payout.

The income start date of DIA’s and FIA’s with income riders, on the other hand, is deferred. With both DIA’s and FIA’s with income riders, it’s contractually defined and is generally at least one year from the purchase date. Although you choose it when you submit your application, most DIA’s have a defined start date; with some wiggle room available on some products. The income commencement date for FIA’s with income riders is flexible other than a potential one-year waiting period and/or minimum age requirement.

Assuming that a DIA meets your retirement income planning needs, you should always consider including a death benefit feature which is optional with most DIA’s. Keeping in mind that the income start date is deferred, and it’s not unusual for the deferral period to be 10 to 25 years, especially when purchasing a DIA as longevity insurance, you probably don’t want to lose your premium, or investment, if you die prematurely.

If you purchase a DIA without a death benefit or return of premium (“ROP”) feature, and you die during the deferral period, not only will the income never begin, your beneficiaries won’t receive anything either. The death benefit or ROP feature serves the purpose of insuring your investment in the event that you die before your income distributions begin.

So how much does it cost to insure your DIA investment by adding an optional death benefit? To illustrate, I recently evaluated the transfer of $100,000 from one of my client’s IRA brokerage accounts to a DIA. My client is approaching her 65th birthday and, like all individuals with traditional IRA accounts, must begin taking annual required minimum distributions, or “RMD’s,” from her account by April 1st of the year following the year that she turns 70-1/2.

Assuming that $100,000 of my client’s IRA is transferred from her brokerage account to a DIA, and assuming that the income from her DIA begins when she turns 70-1/2, she can expect to receive lifetime monthly income of approximately $600 to $700, depending upon the DIA chosen. In one case, the monthly benefit would be reduced by $2.27, from $691.68 to $689.41 with a death benefit feature. In another case, the monthly benefit would be $1.09 less, at $664.41 without any death benefit vs. $663.32 with a death benefit.

In other words, the cost to insure the return of my client’s investment of $100,000 in the event of her death prior to turning 70-1/2 translates to an annual reduction in lifetime benefits of $13.08 or $27.24, depending on the DIA chosen. Not only is there no question about the value of the death benefit in this situation, it would be negligent in my opinion for any life insurance agent not to illustrate the addition of this feature.

Assuming that a fixed income annuity makes sense for you, and further assuming that a DIA is an appropriate solution as a piece of your retirement income plan, always evaluate your potential lifetime income payout with and without a death benefit.

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Annuities Deferred Income Annuities Fixed Index Annuities Retirement Income Planning

Sustainable Lifetime Income When You Need It – Part 2 of 2

Part 1 of this post made the point that if your goal is to receive sustainable lifetime income, in addition to Social Security, fixed income annuities offered by life insurance companies will meet your need. Please read Part 1 to learn about the three types of fixed income annuities, including each one’s income start date.

If you’re seeking total flexibility for your lifetime income start date, then a fixed index annuity (“FIA”) with an optional income rider is your best bet. Unlike single premium immediate annuities (“SPIA’s”) and deferred income annuities (“DIA’s”) where the sole purpose is to provide sustainable income, a FIA can fulfill multiple financial needs, a discussion of which is beyond the scope of this post. When you purchase a FIA, assuming your goal is sustainable lifetime income, you must purchase an optional income rider with an annual income rider fee.

Unlike the start date for SPIA’s and DIA’s which is contractually defined, it is much more flexible with FIA’s. Most FIA income riders, also known as guaranteed minimum withdrawal benefit (“GMWB”) riders, have two requirements when it comes to the income start date:

  1. You must wait at least one year after the contract is issued, and
  2. You must be at least age 50.

Assuming that you meet both requirements, the age at which you begin taking income withdrawals from a FIA is up to you. Unlike Social Security which has an eight-year window for choosing your income start date, i.e., between age 62 and 70, the start date with FIA’s is open-ended once the two requirements have been met.

Similar to Social Security, the longer you defer your start date, the greater your lifetime income payments will be. Unlike Social Security where your benefit amount will increase 7% – 8% each year that you defer your start date, the amount of increase is defined by the income rider provision of each FIA’s contract. Also, unlike Social Security, the percentage increase is generally significantly greater when you cross five-year milestones, e.g., age 60, 65, 70, 75, etc.

Here’s an example from a recent case for one of my clients who are currently in their early to mid 50’s and have invested approximately $250,000 in a FIA with an income rider. If they begin taking income at the younger spouse’s age 63, they will receive annual lifetime income of $20,479. At age 64, the amount increases 6% to $21,708. If they wait until age 65, it increases 19.3% from their age 64 amount to $25,886.

With a FIA with an income rider, in addition to having the security of receiving sustainable lifetime income, you have the luxury of starting your income when you need it. This is in addition to several other benefits offered by FIA’s, a discussion of which has been presented in various Retirement Income Visions™ posts.

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Annuities Deferred Income Annuities Fixed Index Annuities Retirement Income Planning

Sustainable Lifetime Income When You Need It – Part 1 of 2

There have been many articles and blog posts over the last several years about the ability to delay your Social Security retirement benefit start date in order to increase your monthly benefit. I wrote about this in my March 4, 2013 post, Increase Your Longevity Risk with Social Security. Per the post, with a choice of start dates ranging between 62 through 70, you can increase your benefits 7% – 8% each year that your start date is deferred, excluding cost-of-living adjustments (“COLA’s”).

Sources of sustainable lifetime income are few and far between these days with the widespread elimination of monthly pension benefits. The ability to receive a stream of sustainable lifetime income throughout retirement while also choosing your income start date is a rare planning opportunity, the value of which shouldn’t be underestimated.

While the opportunity to receive sustainable lifetime income with a flexible start date is limited, Social Security isn’t the only game in town. If the security of sustainable lifetime income appeals to you and you want to create one or more income streams, fixed income annuities offered by life insurance companies, preferably ones that are highly rated, will also meet your need.

There are three types of fixed income annuities, all of which are contractually guaranteed by the life insurance company from which they are purchased. The three types are single premium immediate annuities (“SPIA’s”), deferred income annuities (“DIA’s”), and fixed index annuities (“FIA’s”) with income riders.

There are several important differences between the three types of fixed income annuities that have been discussed in several Retirement Income Visions™ posts. One of the differences that are relevant to this post is the income start date. SPIA’s and DIA’s have contractually defined income start dates, while the start date of FIA’s with income riders is flexible.

SPIA’s are the most restrictive with a start date that begins one month after the contract is issued, assuming a monthly payment mode is chosen. When you purchase DIA’s, you choose the income start date at the time of application. It is contractually defined with the provision that it cannot begin earlier than 13 months after your contract is issued.

Please read Part 2 of this post next week to learn about the income start date flexibility available with FIA’s with income riders that are designed to provide you with sustainable retirement income when you need it.

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Annuities Deferred Income Annuities Fixed Index Annuities Retirement Income Planning

Is Your Investment Advisor Afraid of Losing AUM?

When it comes to retirement income planning, one of my philosophies is a bird in the hand is worth two in the bush. As defined in Urban Dictionary, this expression means that it is better to have an advantage or opportunity that is certain than having one that is worth more but is not so certain.

One of the ways that I use this approach is to look for opportunities to convert what amounts to a sliver of a client’s portfolio into a deferred sustainable income stream beginning in a targeted year during my client’s planned retirement. The income stream, while it’s often for life, is sometimes for a specified period of time to close a projected retirement income gap (See Mind the Gap).

The opportunities to which I’m referring are sizeable abnormal increases in the stock market that inevitably are followed by market corrections, or downturns. Rather than celebrating what often proves to be temporary good fortune, when appropriate, I will recommend to my clients who need sustainable retirement income that they consider transferring a small portion of their investment portfolio into one or more new or existing fixed income annuities. These include fixed index annuities (“FIA’s”) with income riders, deferred income annuities (“DIA’s”), and single premium immediate annuities (“SPIA’s”).

This is a natural timely conversation that invariably makes sense to the clients to whom I recommend this approach since it is in their best interest. Furthermore, it’s an easy conversation for me to initiate since I specialize in retirement income planning, am a Retirement Income Certified Professional® (RICP®), CPA, CFP® professional, and a licensed insurance agent in addition to my firm being regulated as a Registered Investment Advisor (“RIA”). There’s no conflict of interest when I make the above recommendation to a client since, unlike most investment advisors, my income isn’t tied to a single compensation model.

The compensation model to which I’m referring is assets under management, or “AUM.” While many firms charge financial planning fees, the lion’s share of compensation earned by most traditional investment management firms is derived from AUM. As the name implies, the fee is typically calculated as a declining percentage of the value of a client’s investment portfolio. The greater the value of a portfolio, the smaller the percentage is that is applied to calculate the investment management fee. This is one of several compensation models offered by my firm.

Firms that are tied to an “AUM” compensation model generally don’t offer retirement income planning solutions that require insurance licensing and ongoing specialized insurance and annuity training. Most “AUM” driven firms are reluctant to refer clients to advisors like myself who offer a total retirement income planning approach since, in addition to the obvious revenue loss, this would be tantamount to an admission that they’re unable to provide a total retirement income planning solution.

An “AUM” model, while it’s appropriate for assisting clients with their retirement planning, i.e., asset accumulation, needs, isn’t designed for addressing lifetime sustainable income and other retirement income planning solutions. For clients seeking sustainable retirement income, it’s like trying to fit a square peg in a round hole.

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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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Celebration

Retirement Income Visions Celebrates 4-Year Anniversary!

Thanks to my clients, subscribers, and other readers, Retirement Income Visions™ is celebrating its four-year anniversary. Retirement Income Visions™ published a weekly post each Monday morning beginning four years ago through and including the March 11, 2013 post.

Beginning with the March 25, 2013 post, Retirement Income Visions™ changed to a biweekly publication schedule. This was in response to my acceptance of another retirement income planning writing gig as a Wall Street Journal MarketWatch RetireMentors contributor. I continue to do all my writing on Saturday mornings, enabling me to fulfill my primary goal of providing outstanding, timely service to my clients.

Even with its reduced publication schedule, Retirement Income Visions™ continues to boast a fair number of followers. It has had over 72,000 pageviews in its four years of publication, including over 4,000 in the last 30 days.

In addition to becoming a RetireMentors contributor, I further distinguished myself as a retirement income planning expert when I became one of the first recipients of the Retirement Income Certified Professional® (RICP®) designation from The American College on July 1st. The RICP® educational curricula is the most complete and comprehensive program available to professional financial advisors looking to help their clients create sustainable retirement income.

This past year, Retirement Income Visions™ deviated from its themed approach whereby it historically featured a long stretch of weekly posts focusing on a single retirement income planning strategy. After completing a lengthy series of weekly posts about fixed index and deferred income annuities from August 20, 2012 through November 5, 2012, I began mixing it up with a variety of educational topics.

The November 12, 2012 post, The Smooth COLA, straightened out some misconceptions about Social Security retirement benefit cost of living adjustments. The November 19, 2012 post, Black Friday – Think Roth IRA Conversion, proved to be a very timely post for those who did Roth IRA conversions at that time since they have benefited from a 23% increase in stock prices as of Friday, combined with a significant tax increase that went into effect on January 1st for higher income taxpayers.

The November 26, 2012 through December 17, 2012 posts featured two two-part miniseries about two important Social Security topics, Social Security as a deferred income annuity and considerations when choosing a Social Security starting age.

The January 7, 2013 post, The 2013 Tax Law Schizophrenic Definition of Income – Part 1, was timely, as it was quoted extensively and linked in Robert Powell’s MarketWatch January 11, 2013 Now is the Time for Tax-Efficient Investments article. The January 7th post and the January 14th, 21st, and February 4th posts, which included Part 2 of the January 7th post and a two-part miniseries, New Tax Law – Don’t Let the Tax Tail Wag the Dog, provided readers with a comprehensive understanding of the new tax laws that went into effect on January 1st.

The next four posts, beginning with the February 11, 2013 post, The Almost Irrevocable Retirement Income Planning Decision, through the March 4, 2013 post, Insure Your Longevity Risk with Social Security, featured a series of four timely Social Security topics.

Retirement Income Visions™ really began mixing it up, beginning with the March 11, 2013 post, Consider the Future Purchase Option When Buying Long-Term Care Insurance, through the July 29, 2013 post, Immediate Annuities – Where’s the Planning? The eleven posts in this stretch presented a number of different topics, including long-term care insurance, retirement income planning considerations and strategies, fixed index and immediate annuities, Medicare, longevity insurance, budgeting, and personal financial management systems.

As I’ve traditionally done in previous “anniversary” posts, I would like to conclude this post by thanking all of my readers for taking the time to read Retirement Income Visions™. Once again, a special thanks to my clients and non-clients, alike, who continue to give me tremendous and much-appreciated feedback and inspiration. Last, but not least, a big thank you to Nira, my incredible wife, for her enduring support of my blog and MarketWatch RetireMentors writing and other professional activities.

Categories
Annuities

Immediate Annuities – Where’s the Planning?

Retirement Income Center

As a retirement income planner, in addition to the Retirement Income Visions™ blog posts and MarketWatch RetireMentors articles that I write, I read a lot of retirement planning and retirement income planning (If you’ve been reading my articles, you know there’s a distinct difference between the two disciplines) articles written by other writers.

While I’m happy to see that immediate annuities are often recommended as a potential retirement income planning strategy, I get concerned when they’re touted as the only income solution, especially in today’s low-interest-rate environment.

I have discovered after questioning writers about their recommendation that knowledge about other types of income annuities is lacking in many cases.

An immediate annuity is a fixed income annuity for which annuitization begins one month after date of purchase with a single premium. For those of you who aren’t familiar with, or need to brush up on your understanding of, annuities, please refer to the following five terms that are defined in the Glossary of Terms: annuity, annuitization, fixed annuity, fixed income annuity, and immediate annuity.

From a planning perspective, assuming there isn’t an existing retirement income plan in place that includes deferred fixed income annuities, it’s my belief that the recommendation of an immediate annuity as the only income solution in many cases demonstrates a lack of planning and understanding about other types of annuity income strategies, including how they can interact to optimize an individual or family’s sustainable income.

By definition, annuitization, or the structured payout, of an immediate annuity begins one month after date of purchase of the annuity contract. Assuming that a recommendation is made today to purchase an immediate annuity with a lifetime payout, the lack of income deferral opportunity, combined with today’s low interest rate environment, is generally going to result in a relatively small monthly payment. While the payment is guaranteed by each individual life insurance carrier, subject to each carrier’s claims paying ability, and is subject to favorable income tax treatment, it nonetheless will generally be modest at best.

Assuming that you have at least five years until retirement, you have the ability to implement retirement income planning strategies that include fixed income annuities with deferred payments as part of your plan. This includes deferred income annuities (“DIA’s”) and fixed index annuities (“FIA’s) with guaranteed lifetime withdrawal benefits (“GLWB’s”), generally offered as income riders. Please refer to these terms in the Glossary of Terms if you’re not familiar with them. In addition, you may want to read the five-part series, FIA’s With Income Riders vs. DIA’s: Which is Right for You?

The deferred payment nature of DIA’s and FIA’s with income riders provides insurance carriers with the opportunity to invest your premium for an extended period of time as defined by each annuity contract. How does this benefit you? For starters, there will be no taxation of your investment between the date of your purchase and the date that you begin your withdrawals, otherwise known as tax deferral. More importantly, the deferral period provides you with the ability to receive a larger monthly income stream than a stand-alone immediate annuity solution. Furthermore, the timing of the commencement and amount of your payments can be customized to meet your financial needs.

An immediate annuity, when presented as the only income strategy, is generally not appropriate as a retirement income planning solution in many cases in my opinion. A holistic retirement income plan that includes deferred fixed income annuities is often a preferable alternative.

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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.