| Last July, the U.S. Treasury issued regulations allowing Qualified Longevity Annuity Contracts as tax-deferred annuity products. The new rules allow deferment distribution of payments, within qualified retirement plans, until up to age 85, far beyond the required minimum distribution (RMD) age of 70 ½.
Now, holders of 401(k) or IRAs can use up to 25 percent of their account balance across all their retirement accounts, or $125,000, whichever is less, to buy a QLAC.
Deferred Income Annuities (DIA) constitute about 1 percent of total annuity sales now. But could they catch on as those nearing retirement assess the possibility that they will outlive their money?
Wendy Carter, defined contribution director with The Segal Group, headquarted in New York with a Boston office, said, “As more of retirees’ income comes from defined contribution sources, the need to provide a longevity hedge will become more important. While a complex decision, a deferred option provides a longevity hedge without having to purchase an immediate annuity.”
Carter says that the dollar and percentage limits on QLAC purchases should allow many participants to purchase a reasonable amount of deferred income. However, she said, survey data shows that most close to retirement have account balances well below the $500,000 that would allow a $125,000 QLAC purchase.
Other real-life dilemmas concerning annuities come from two ends of the life-time horizon spectrum, involving the inevitable death and taxes. Investors in annuities may find, too early, that they need more cash than their current income stream supports. They’re faced with paying surrender fees and penalties – and taxes.
Also, with many DIA products, if the annuitant dies before payment starts, the investment is not refundable and heirs, if any, get nothing. The AIG product reportedly addresses the issue of loss of investment if the annuitant dies before payments begin. Treasury regulations state the death benefit is like a required minimum distribution for that year and is not eligible for rollover.
Late last year when the AIG product debuted, brokers questioned whether the investment in a qualified-plan QLAC can be converted to a Roth IRA just before the client starts drawing down. The answer: Once qualified money in a QLAC is converted into a Roth, it’s no longer a QLAC (conversely, longevity annuities bought within Roths are not considered QLACs because Roths have no RMD requirements), so the suggestion was that QLAC investors examine this issue before reaching the maximum qualified-plan distribution age of 70 ½. In essence, they may have to hedge their bets.
Also, brokers inquired who is responsible to determine that the annuity purchase meets the Treasury guideline purchase limits, and whether the QLAC originator would need to code such confirmation into its order entry system. Originators don’t have that information on hand – the IRS does.
Gender Divide
Carter brings up another concern. In an article published last month, she noted that annuities purchased within qualified plans must use unisex mortality tables, while annuities purchased through IRAs are allowed to use gender-based tables. Because women have longer life expectancies than men, their individual annuity rates are higher than men’s by approximately 4 to 8 percent. While group rates are usually lower than individual rates, men’s individual purchase rates may be lower than the unisex group purchase rates, Carter said. “These pricing differences mean that group purchasing power, frequently referred to as institutional pricing, which is one of the key advantages of retirement plans, is reduced – or perhaps lost entirely. As a result, women generally would benefit from purchasing QLACs within the plan and men might benefit from purchasing them within IRAs.”
Theory And Practice
Rising rates of return might make QLACs more attractive for long-term investors. Also, an increased awareness on the part of younger investors of the value of a future guaranteed income stream; the earlier in their lives they invest, the less they have to invest to get a higher payout, with the potential to draw out far more than they put in.
As of January, only AIG has taken advantage of the new rules to offer a DIA that meets Treasury guidelines for a QLAC. It’s an offshoot of a previously-introduced AIG product. According to AIG, a portion of the tax savings would be applied to the contract purchase, with income distributions beginning far later.
Other QLAC approvals won’t come until this summer from other annuity companies. The deadline for companies to elect to offer QLACs is January of 2016.
Email: coneill@thewarrengroup.com
