Understanding whether this offering preys more on your fears about aging
If you’re approaching or already in retirement and your fear of outliving your savings steadily grows, consider this: You pay a premium to an insurance company and in return a lifetime income kicks in when you turn a certain age.
But the aging buyer should beware: These products often work in only limited circumstances and often just prey on your fears.
Longevity annuities have increasing visibility due to complex tax laws. Insurers promise guaranteed income for life and fewer taxes through what’s called a qualified longevity annuity contract (QLAC). Before you reach for the pen, though, understand longevity annuities’ fine print.
The Basics Of Longevity Annuity Contracts
Annuities come in two types: variable and fixed. With a fixed annuity (the type you can use in a QLAC), you make a lump-sum or series of payments to the insurance company. In return, the insurer pays you a minimum rate of interest on your contribution plus a series of periodic payments over a number of years.
With a deferred annuity, your payments begin sometime in the future, rather than immediately. A deferred fixed annuity that provides payments for the life of an individual or couple is a longevity annuity.
Regulations allow longevity annuity contracts in individual retirement accounts and qualified retirement plans, creating the QLAC. This created an exception to required minimum distribution withdrawals on these accounts, allowing you to defer your RMD until age 85 (an increase of almost 15 years over previous rules) on the portion of your retirement plan funds in the QLAC.
A longevity annuity must meet the following requirements to qualify as a QLAC:
- The amount of premiums paid cannot exceed the lesser of $135,000 or 25% of your IRA.
- Payments from the QLAC must start no later than age 85.
- The QLAC must provide fixed payments – you can buy a rider for cost-of-living adjustments (COLAs).
- The QLAC cannot have a cash surrender value. In other words, it must be irrevocable and illiquid. It can carry a return-of-premium death benefit payable to your heirs as a lump sum or stream of income.
Before you consider leveraging a portion of your retirement savings for a QLAC, understand the risks.
The Risks
- Inflation can degrade the purchasing power of your annuity’s guaranteed income.
- Insurers’ COLAs will diminish the amount of money available in your initial payments.
- A longevity annuity is essentially a hedge that you will live to a very old age. If you die before receiving your principal back, the balance after your death becomes the property of the insurance company unless you bought a return of premium death benefit (which significantly lowers your returns).
- The QLAC is irrevocable and illiquid – you can’t again access any money you contribute until your contracted payout.
- The agreed-to payments are largely dependent on the strength and stability of the insurance company. While the insurer’s solvency might never become an issue, your payouts are not ironclad.
Deferring withdrawals to reduce your taxes for up to 15 additional years may seem attractive. But you need to understand the QLAC’s performance compared with other investment options, such as a balanced portfolio, over that time.
Again, two main (potential) benefits of a QLAC: guaranteed income for life and tax advantages of deferring the RMDs on a portion of the QLAC.
Still, all of that might not be compelling reasons for you to use QLACs or any form of annuity. Other options, such as a low-cost diversified portfolio, can often be more effective.
Many financial professionals might suggest that only under very limited circumstances – you spend a lot relative to your assets, for instance, or you have a high aversion to risk – a fixed annuity may be appropriate.
Generally, beware of insurance products targeting your anxieties about aging.
Important Disclosures
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Fixed annuities are long-term investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply.
This article was prepared by FMeX.
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