As life expectancies lengthen and many retirements grow to 30 years or longer, more and more Americans are deciding to supplement traditional retirement savings, such as individual retirement accounts, 401(k)s, pensions and Social Security. They’re looking for other simple, guaranteed income sources, and qualified longevity annuity contracts can help.
When you buy a QLAC, you commit money now in exchange for a monthly paycheck starting at some point in the future. This might make them sound like other deferred income annuities, but they’re special: You can purchase them with tax-deferred savings from your qualified retirement plan.
Here’s a closer look at these products.
How QLACs work
A QLAC is a type of deferred income annuity. With such products, an individual or couple will pay a premium — all at once or over time — and elect when to receive the income. The insurance company, in return, agrees to provide a predetermined, guaranteed monthly payout for life. You can think of it like a pension you buy for yourself.
For those familiar with the annuity market, QLACs are just like qualified immediate annuities, except that payments start at least a year or two in the future, not right away. Why wait? Because payments increase significantly the longer you delay them.
Here are the best payout rates based on recent data for insurers with a rating of at least A from A.M. Best, a credit-rating agency:
|Current age / income start age||Annual payout rate|
|66 years old / 71 years old||9.4%|
|66 years old / 75 years old||13.8%|
|66 years old / 80 years old||24.2%|
|66 years old / 85 years old||50.2%|
|Source: Abaris platform, which provides quotes from 10 leading insurers. Data as of June 17, 2016. Figures based on a single, male annuitant with a life-only $100,000 premium product. State of issue: Pennsylvania.|
A 2014 U.S. Treasury ruling exempted certain deferred income annuity products from the standard required minimum distribution rules, which force those older than 70½ to withdraw a specific amount of money from their tax-deferred retirement accounts each year. This ruling created the QLAC designation.
The amount you use to purchase a QLAC is now exempt from your required minimum distribution calculation. That means lower required minimum distributions for you while the QLAC income is deferred.
But you should note that the vast majority of annuities aren’t QLACs. Here are some of the requirements:
- QLAC designation: Annuities must be specifically designated as QLACs to qualify for this special treatment. If you bought a product that wasn’t labeled a QLAC, it can’t be reclassified.
- Fixed payouts: A QLAC cannot have any market-based adjustment features, with the exception of an inflation adjustment feature. This means that payouts must be predetermined. If you want your payouts to go up if the stock market goes up, for example, a QLAC isn’t for you.
- Premium limits: QLACs are subject to premium limits. If you have less than $500,000 in your IRA or 401(k), you can’t use more than 25% of those assets to buy a QLAC. This is calculated based on your balance as of Dec. 31 of the previous year. If you have $500,000 or more in those assets, you can use up to $125,000 to buy a QLAC.
- Deferral limits: You can defer payments until you’re 85.
What does this all mean for you? First, don’t assume a product is a QLAC unless it’s officially designated as one. Second, make sure the amount you’re spending to buy one doesn’t exceed the IRS maximum. And remember that products that provide death benefits and inflation adjustment features can qualify, but in general, these optional features will result in lower payouts. For the full QLAC rules, see the IRS bulletin.
Who should consider a QLAC?
Of course, QLACs aren’t for everyone. But you might consider one if your other retirement income — such as Social Security and pension benefits — won’t cover your regular expenses and you want more certainty, meaning you’re looking for an insurance product rather than an investment product. They can also help if you’d like a tax deferral on required minimum distributions.
If you’re older than 45 but not too far into retirement, have average or above-average health and have between $250,000 and $5 million in retirement savings, a QLAC could be a good choice.
You probably won’t want to buy one if you’re in below-average health, already have a large pension or want all of your portfolio to have market exposure. If your assets total less than $250,000, you might want to diversify with a product that has cash value so you can draw on the funds. And if your assets total more than $5 million, the dividends and interest you receive could generate sufficient retirement income.
Most advisors don’t recommend QLACs because they don’t build cash value, unlike many insurance products used for retirement-planning purposes. But if you use only a small portion of your overall portfolio to purchase a QLAC — usually 5% to 15%, and never more than 25% — this is usually not an issue. The rest of your assets will provide this liquidity.
Other opponents argue that QLACs have high fees. They have a one-time fee of about 3%. But as an insurance agent and provider of income annuities, I would argue that fee is reasonable, especially compared to the fee your financial advisor charges you — usually about 1% of your total assets each year.
Finding a QLAC
There are now about a dozen companies that offer QLACs, including New York Life (rated A++ by A.M. Best), Guardian Life (A++), Pacific Life (A+), Lincoln Financial (A+), Mutual of Omaha (A+) and Foresters (A). Before you buy, you’ll want to compare quotes and product features — and remember, not all companies sell all products in all states.
Some financial advisors are unfamiliar with QLACs and the application is notoriously complicated, so if you want to buy, make sure you’re talking to someone who knows the ins and outs — preferably a chartered financial analyst, certified financial planner or retirement income certified professional.
And keep in mind that some advisors are paid by commission, which might influence their recommendations. Ask your advisor exactly how he or she is being paid to make sure you’re confident in the advice you receive.
Nimish Shukla is a chartered financial analyst, insurance agent and the co-founder and chief operating officer of Abaris Financial, an online provider of income annuities, in New York. Request a free consultation with Abaris Financial.