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Looking for a New Acronym? Try QLAC

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Jonathan Kinney
BKK Wills, Trusts and Estates Newsletter
December 2014

What's a QLAC? Effectively, it is a Qualified Longevity Annuity Contract that's owned by a traditional IRA or 401K plan.

Why is this important and what is a “Qualified Longevity Annuity Contract”?

Longevity annuities provide income starting at a future date. As a number of commentators have pointed out, most retirees are not worried about retirement in their early years because they will have assets in their retirement account, but they're often worried about whether or not their traditional retirement accounts will continue to provide “income” during the later years of retirement. As the TV ad suggests, “what happens if I outlive my retirement income?” Effectively, longevity annuities provide protection in this situation.

There are a number of variations to the longevity annuity. One of the most common is a plan that starts paying out at a specified age. For example, 80 years old – this type of plan pays the highest payout because the annuity recipient is basically taking the risk themselves that they live until 80 and beyond. The recipient receives funds for as long as she lives beginning at age 80 and beyond; however, if she dies before 80 she will not receive anything. There are, of course, variances to this type of plan since most people are not inherently gamblers. For example, there are longevity annuities that guarantee a lifetime payment regardless of whether you die early. For example, you can be guaranteed a lifetime payment beginning with the year 80 but if you died either before the initial payment or in the fourth year of the payout you'd be eligible for a total of 6 to 10 additional years of annuity payments. This plan is called a life with a 10 year certain policy. Other policies are structured so that if you die before a certain date, one hundred percent of the paid in premium (but not interest on accumulated income) will pass to your beneficiaries. There are any number of variants to these structures. Obviously any of the annuity payments that have a guaranteed payment will pay less on a monthly basis than a policy that requires a beneficiary to live to a certain age before the payout begins.

What's important with the new IRS regulations is that the IRS will allow deferral on the normally required minimum distributions which have to begin at age 70½ . The rules dictate that you can use 25% of the amount in your qualified accounts or $125,000 on longevity annuities, whichever is less. You also cannot designate the income start date beyond age 85.

Effectively what this means is that you don't have to count the funds spent on the Qualified Longevity Annuity as part of your required minimum distribution calculation. Assuming that you’re close to the age when you'll have to take out the minimum required distribution from your 401(k) or IRA and further assume that your anticipated balance in your retirement account will be $600,000. Effectively, that means you can take 25% of the amount in your qualified account ($150,000) or $125,000 and purchase a Qualified Longevity Annuity. In this case since 25% of the $600,000 IRA is greater than $125,000 you are limited to $125,000 but for purposes of calculating the minimum required distribution, you use $475,000 for that calculation and not $600,000. You can delay the distribution under the Qualified Annuity up to age 85, rather than 70½. Additionally, a Qualified Annuity can also be structured so that the payments are made over your life and your spouse’s life, but again this would affect the monthly payout. This strategy only works if you do not need the required minimum distributions from the IRA or 401(k) plan beginning at 70½.

Longevity annuities work primarily to guarantee that you won't outlive your retirement funds. Longevity Annuities are clearly not for everyone. Like any insurance product they involve commissions and fees. Like any new structured product, our assessment is that choices will be somewhat limited in the beginning but as time goes on we will start seeing options added to the “plain vanilla plans” as the insurance companies figure out what strategies will be most attractive to individuals.

Currently, Longevity Annuities only make up a miniscule part of the annuities market. With changes to permit a QLAC, commentators are expecting Longevity Annuities to make up a much larger share of future annuities. It is also quite possible that QLACs will become popular with younger beneficiaries such as a couple in their 40s that have funds in their IRA and 401(k), but are concerned that they want to provide for additional income beginning years after their initial retirement.

We anticipate that in a few years products will be more variable and better able to fit individuals’ needs. One of the nice things about a QLAC is that it's fairly easy to understand. Typically it's a one-time payment up to the maximum of $125,000. It is not anticipated that any annual fees will be charged, although obviously there will be internal fees that will affect income. This is particularly true if the payment is not a guaranteed payment, but a hybrid with a minimum payment with an escalator provision should investment income exceed certain standards. Commentators believe that QLACs will be on the market by the end of 2014.