Qualified Longevity Annuities Contract: QLAC Pros and Cons
Longevity Annuities: Like spinach — you might not want to eat it, but it is good for you…
What is a QLAC? How is QLAC Different from Other Annuities?
There are so many different types of annuities.
QLACs are defined by the following key differences. Let’s take each aspect of the QLAC name one by one:
Annuity Contract: Let’s start with defining “annuity contract.” An annuity is a financial product sold by insurance companies. It guarantees reliable income to the purchaser (annuitant). When you purchase an annuity, you are contracting with the insurer to exchange a lump sum of money for a guaranteed monthly paycheck.
Qualified: This refers to the fact that this type of annuity is purchased with “qualified” — also known as tax advantaged — funds.
But there is more, in addition to the regular tax advantages, a QLAC offers additional benefits over traditional 401ks and IRAs. As long as the annuity complies with Internal Revenue Service (IRS) requirements, it is exempt from the required minimum distribution (RMD) rules until payouts begin after the specified annuity starting date.
Longevity: Fixed annuities give you income for a fixed period of time. Longevity or lifetime annuities give you income for life — no matter how long your life (and perhaps your spouse’s life) lasts.
While not part of the name, it is also important to point out that when you buy an annuity, you can specify that the income stream starts right away or at some point in the future. A QLAC is usually designed to start at some point in the future and is meant to help you cover costs later in life.
QLAC Pros and Cons
More than half of Americans are in danger of not being fully covered for their estimated expenses during retirement, according to a study from Fidelity Investments.
The key benefit of a QLAC is that it could help you cover more of your retirement expenses. And, you have the freedom to choose when you want to start receiving fixed income.
Best of all, deferred lifetime annuities reduce the risk that you will run out of money.
Here are an additional 6 QLAC advantages:
1. Tax Deferred Status
The QLAC lets you purchase the annuity with qualified funds — retaining your tax advantages.
2. No Required Minimum Distributions (RMDs) Till Later
Most traditional tax-deferred retirement plans have required minimum distribution (RMD) rules, which require a person to begin receiving their payments by age 70½.
Longevity annuities purchased with qualified funds allow you to defer any mandatory withdrawals until age 85.
3. Improved Retirement Readiness
The Employee Benefit Research Institute (EBRI) measured the impact of QLACs on retirement readiness in its Retirement Security Projection Model and found the product can provide great benefits for improving financial security for older seniors.
The study found that: “…the use of QLACs, through the transfer of longevity risk to the insurer, provides a significant increase in retirement readiness for the longest-lived quartile with only a small reduction for the general population,” said Jack VanDerhei, EBRI research director and author of the report. “Sensitivity analysis on the QLAC premia resulting from likely increases in future interest rates provide even more favorable results.”
EBRI looked at two scenarios where QLACs can boost retirement readiness: converting 15% of a 401(k) balance with a current employer to a QLAC premium over 10 years and converting the accumulated value of employer 401(k) contributions to a QLAC at retirement age, with employees either opting in or opting out.
In both scenarios, purchasing a QLAC resulted in a small boost in retirement readiness, and younger generations were more likely to benefit more than early baby boomers.
“While it’s still too early to know how individuals’ demand for these products and the insurance industry’s supply of QLAC options will eventually modify the market for longevity annuities, it is useful to model the degree to which QLACs can improve retirement security,” VanDerhei said.
4. Eliminates Risk/Guaranteed — Improves Peace of Mind
QLACS eliminate the uncertainty of the financial markets. If you are invested in stocks, you are unsure of what money might be available to you at any specific time. The QLAC eliminates the guesswork from planning for retirement income.
With a QLAC, you know how much retirement income you will have and when.
5. Cover for a Long Term Care Need
Some people use a QLAC to specifically cover a future long term care need. Long term care is one of the biggest wild cards in retirement planning.
6. Spousal Protection
QLACs can be purchased to cover both you and your spouse. This means that if you die before they do, they will continue to receive the income.
Downsides: Purchasing Longevity Annuities or a QLAC — It Is Like Eating Spinach
While there is some evidence that a QLAC can improve retirement outlooks for some, few are looking at the product as a serious retirement income option. Some even refer to QLACs as spinach – something that might be good for you, but not very popular.
The number of workers interested in purchasing this option at some point in their life is low, with only 8% indicating they were very interested and 30% saying there were somewhat interested in EBRI’s study. By comparison, 59% said they were not too interested or not at all interested.
So, what are the actual slimy downsides?
1. Lack of Control
The flip side to being able to guarantee income is that you lose control over the money in the short term.
2. Might Never Get Used
Some people fear that they won’t live long enough to get their QLAC income. It is important to select a reasonable start date for payments.
3. Lack of Inflation Protection
The QLAC does not offer inflation protection. So, you will want to be careful to think through how much income you will need in the future and be to purchase a QLAC that will cover your inflation adjusted needs.
If you already have qualified dollars in a tax-deferred retirement plan like a 401(k) or an IRA, it may be worth your time to consider purchasing a QLAC and converting some of those savings into income you can start receiving later during retirement. Use an annuity calculator to estimate your income or see how an annuity fits into your overall retirement plan by using the NewRetirement Retirement Calculator.
4. Need to Trust Your Insurer
You need to be sure that you are purchasing a QLAC from a company you trust. Look at ratings from A.M. Best, Fitch, Kroll Bond Rating Agency (KBRA), Moody’s and Standard & Poor’s to be sure you are dealing with a highly reputable company.
5. There Are Limits to How Much You Can Invest in a QLAC
As of Jan. 1, 2018, the limit for how much of your tax advantaged savings you can convert into a QLAC is $130,000 — this may or may not provide adequate income.
For example, if you were a 60 year old male purchasing a $130,000 QLAC today, you could get around $770-$1,425 in income starting 10 years from now. This may or may not be enough for your needs.
QLAC Calculator: Model a QLAC
Don’t trust this list of QLAC pros and cons. It would be best to investigate whether or not a QLAC would be a good or bad idea in your particular situation.
There are a couple of ways to estimate how a QLAC fits into your overall retirement plan:
Lifetime Annuity Calculator: Use the Lifetime Annuity Calculator to find out how much lifetime income your savings could buy — starting now or at some point in the future. Or, if you know how much income you need, learn what it will cost upfront.
Model a Lifetime Annuity in the NewRetirement Planner: The lifetime annuity calculator is also built into the NewRetirement Planner. This is probably the best way to visualize the impact of a QLAC on your future. In the Planner you can specify from which account to withdraw funds for the annuity and then immediately see the impact on your out of money age, cash flow and more.