New Opportunity for Generating Lifetime Income
A survey of people aged 44 to 75 found that 61% fear running out of money in retirement.1 There may be various personal reasons behind this concern, but the decline of traditional pensions, combined with longer life spans and rising medical expenses, has created an uncertain future for many Americans, including those who have put away a solid nest egg for retirement.
A recent IRS decision opened a new opportunity for retirement plan owners to turn a portion of their retirement savings into a guaranteed future income stream using a qualified longevity annuity contract (QLAC). Although longevity annuities (sometimes called longevity insurance) are not new, the IRS decision makes it more effective to purchase and hold an annuity in a qualified retirement plan such as a traditional IRA or a 401(k). Here’s how it works.
A longevity annuity is a deferred fixed annuity that delays lifelong income payments until a future date — often when the contract owner reaches age 80 or 85. Because the annuity income is deferred, the payouts are typically higher in relation to the premiums than they would be if the annuity income had been paid immediately. Purchasing the annuity at a younger age with a longer deferral period would generally give you a better premium-to-income ratio.
In the past, it would have been counter-productive to purchase a longevity annuity in a qualified retirement plan, because the amount used to purchase the annuity would have been included in the account balance to determine required minimum distributions (RMDs). The new IRS ruling allows retirement plan participants to use the lesser of $125,000 (inflation adjusted) or 25% of their account balances to buy a QLAC, with the annuity’s value excluded from the account balance used to determine RMDs.
Having a QLAC might allow you to take larger retirement plan distributions earlier in retirement, knowing that you will have a guaranteed future income from the annuity. Income payments must begin no later than the first day of the month following the participant’s 85th birthday.
Options and Limitations
The rules also allow for the continuation of income payments throughout the lifetime of a beneficiary (such as a surviving spouse) and/or the return of premiums (minus payouts) as a death benefit. However, these options will either raise the purchase price or reduce income payments later in life. Without the optional death benefit, insurers will generally keep the premiums paid if the annuity owner dies, even if payouts have not yet begun.
Cash-out provisions are not allowed in QLACs, so any money invested in the annuity is no longer a liquid asset, and you may sacrifice the opportunity for higher investment returns that might be available in the financial markets. (By contrast, nonqualified annuities may offer a cash-out option that permits withdrawals during the deferral phase, but surrender charges typically would apply.) Like other distributions from tax-deferred retirement plans, income payments from QLACs are fully taxable. (With nonqualified annuities purchased outside a retirement plan, only the earnings portion is taxed.)
Like most annuities, a QLAC typically would be purchased with a lump sum. However, if your employer chooses to offer a QLAC option in your retirement plan, you may be able to invest through regular salary deferrals.
Annuities are insurance-based contracts that have exclusions, contract limitations, fees, expenses, termination provisions, and terms for keeping them in force. Any guarantees are contingent on the financial strength and claims-paying ability of the issuing insurance company.