The Internal
Revenue Service took a needed step toward making delayed or longevity annuities
a viable option for retirement savers, with its July issuance of qualifying
longevity annuity contract (QLAC) final regulations. This action will make it more attractive for
savers to use retirement assets to purchase longevity annuities, which begin
their payment stream at an advanced age, such as age 80 or 85. The key to QLAC appeal will be the ability to
exclude annuity contract costs from required minimum distribution (RMD)
calculations, and the resulting taxation that generally begins at age 70 ½
. Up to 25 percent of aggregate IRA and
employer retirement plan accumulations – not to exceed $125,000 – can be used
for QLAC purchase and still be excluded from the balances that will determine
taxpayer RMDs.
The question
no one is able to answer at this point is how attractive this investment option
will be to those with assets accumulated in IRAs or employer plans. It is a safe assumption that it will take
time for interest to grow. Longevity
annuities are not actually a new product, but until now they did not offer the
tax benefits provided by these final regulations.
Another term
some use for longevity annuities is “death insurance.” If structured to begin payout at an advanced
age and to last throughout the annuitant’s lifetime, he or she can be assured
that they will not outlive these funds. A valuable assurance to be sure. Until
now, longevity annuities have typically been purchased with nonqualified assets
as part of a comprehensive financial plan intended to provide for an individual
or a couple throughout their retirement years.
At the risk
of over-generalizing, it is likely that the buyer of a longevity annuity is a
person of above-average wealth, able and willing to part with a substantial sum
to purchase a contract whose promised return does not begin until at a date
that may be 10, 15 or 20 years in the future.
The younger the buyer, the less expensive the longevity annuity, but the
longer one will wait before seeing a return on the investment. In some cases, depending on how a longevity
annuity is structured, there could be no
return if the annuitant dies and there is no residual payment stream guaranteed
to a beneficiary. Given these realities,
the longevity annuity has understandably been a niche product to date.
The QLAC,
after years of congressional and public policy advocacy for it, now offers the
special tax incentive of excluding the purchase value from RMD
calculations. Will workers and younger retirees
seriously consider this option? How will
it mesh with today’s qualified retirement plan environment? Will QLACs be embraced, or remain a niche
investment product that lacks the broad appeal its advocates have hoped for?
It’s no
secret that there is a certain amount of hesitation on the part of plans
participants and IRA owners today to annuitizing an IRA or retirement plan
balance. In an earlier time when defined
benefit pension plans were common, a “promise to pay” was accepted with less
hesitation. But in today’s largely
defined contribution world, in which I will include IRAs, there is greater
reluctance to give up control of a large sum of money in exchange for a promise
to pay. Failures of insurance companies,
the source of annuities, are not an everyday event. But high-profile insurance company failures
of the past, and the late financial meltdown that led us into the recent
recession, have made many savers reluctant to give up control of their assets. A longevity annuity that does not begin payments
until well into the future may take some getting used to for a lot of savers. Even in cases where this is an alternative
that should be considered.
In the
employer-sponsored retirement plan realm, with the exception of defined benefit
pension plans, most participants receive lump sum payouts. The defined contribution plan world has to an
increasing degree moved away from annuitized distributions. If a QLAC is purchased under an employer plan
the assets would essentially leave that plan when paid to an annuity provider,
but continue to be accounted for as a plan investment in order to enforce the
QLAC purchase limits. It’s clear that shifts
in both philosophy and logistics may be needed if QLACs are to make inroads in
DC plans.
For these
reasons some feel that QLACs are most likely to gain initial acceptance as IRA
investments. This, in turn, has led to
speculation as to whether there could be some “asset flight” from employer
plans when a plan participant eligible for a distribution wants to purchase a QLAC
when it is most affordable. For many
this will be while they are still in the work force. With QLACs, more so than many retirement issues today, the operative expression is “more to come.”
