QLACguru Blog (cue-lack goo-roo blahg)

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Articles, wit and wisdom about retirement planning, tax management and living a long life.


 It is utterly false and cruelly arbitrary to put all the play and learning into childhood, all the work into middle age, and all the regrets into old age.  -- Margaret Mead

In your fifties or sixties? 

If you’re like most people our age, you may have a regret or two. 

Research by Cornell Psychology Professor, Thomas Gilovich, shows what we regret most in life is not the mistakes we’ve made in the past. Instead, the things we didn’t do produce the most regrets. It turns out that we regret the most are the times we failed to act.

Regrets and Retirement Planning

Nowhere is this truer than in retirement planning. For most of us, our regrets span both saving for retirement (never enough) and failure to manage our retirement once it has started.  

Rare is the individual who can say that they have it completely together in planning and managing their retirement.  If you feel this failure applies to you, it turns out you are in good company. A 2018 Northwestern Mutual study found that 21 percent of Americans of all ages have nothing at all saved for the future. Another 10 percent have less than $5,000 saved for their golden years. A 2017 study by Government Accountability Office (GAO) analyzed retirement savings.  The study found the median retirement savings for Americans between age 55 and 64 were $107,000.  The reasons for our nation’s savings shortfalls are as varied as people themselves. Examples include: 

  • Failure to get into the retirement savings habit;
  • Unexpected and uninsured loss of an income provider;
  • Divorce; 
  • Protracted family illnesses; 
  • Education expenses or debt; 
  • Investments that have gone awry. 

Professor Gilovich would tell us that no matter what the reasons are, they don’t matter now. What is important is what happens next. Professor Gilovich advises that we tackle our potential future regrets head-on. “As the Nike slogan says: ‘Just do it’; Don’t wait around for inspiration, just plunge in. Waiting around for inspiration is an excuse. Inspiration arises from engaging in the activity.”

How to “Just do it” for your retirement?

What follows is a short guide to “just doing it.”

1. Start by calculating retirement assets and income. Your first step should be to look at your financial situation with the long view in mind. First, add up your existing assets. Factor in social security (click here to see the social security administration’s benefits estimator). The benefits estimator tool may provide you with some important insights into how long you will want to keep working. For example, while you may start to receive Social Security at age 62, you should study your options. The Social Security Administration pays a smaller benefit to people who begin receiving payments at age 62. It pays more, for example, to people who wait until age 66 or age 70. If you enjoy what you are doing, are in good health, and can keep working, you may enjoy receiving benefits later. Indeed, Social Security benefits increase every month you do not take them until you reach age 70. After a retiree’s 70th birthday, there is no economic benefit for continuing to wait. For more on this topic go to the Social Security Benefits Planner. You may also find useful an article about the tradeoffs between taking early and late distributions in this article by the Motley Fool.

2. Project Living Expenses in Retirement. You need to look at what you are going to need in retirement to cover your expenses.  Be sure to include rent, food, medical expenses and other costs of day-to-day living. If there is a shortfall – and there is for many of us – don’t panic.  No matter how small your savings is now, the most important thing you can do at this stage is to begin. Start by projecting what your expenses are. 

3. Start Problem-solving. Here are some examples of places in your budget where you can find money:

a. Save on Housing Expense. A smaller home or apartment may make sense now.  Many of us with grown children live in houses that are far too large for our needs.  Moving to a smaller home in a different state, county, or even a school district can be liberating. Such a transition can mean less monthly living expense and less day-to-day maintenance. Often, the result is a net improvement in the quality of life.

b. Save on Debt. This time of life is often a great time to pay off credit card debt built up over the years.  Helping your kids through their various stages in life can create credit card debt.  Debt consolidation either using home equity or other forms of credit can make sense. Also, it may be a good time to explore refinancing to a 15-year mortgage. A fifteen-year mortgage may move you to a net higher payment. Paying off your mortgage in your fifties and sixties paves the way to rent-free living in your seventies and eighties. Even more enticing, after age 62 a reverse mortgage becomes an option. 

c. Save on Day-to-day Expenses. Don’t be ashamed to grab senior discounts, they are everywhere. Look for them in grocery stores, movie theaters, ballparks, hotels. Finding and using these discounts can become a part of your routine. To get you started, here is a list of senior discounts

d. Consider Small Investments that Reduce Your Living Expenses. For example,  you can reduce your electricity costs. Many states provide incentives for residential investments in solar power and geothermal heating and cooling. The Federal Government also provides an investment tax credit for these kinds of investments.  Start a garden. If you spend a lot of money watering on your property, a humble rain barrel can provide decades of savings on irrigation.

e. Consider Working Longer. For those who are able, keeping working post-retirement is a sensible way to fill up the savings tank. This may mean a transition to a second career which may be different from what you pursue in the present. For example,  after working many years in larger companies, you may move to more entrepreneurial endeavors. Self-employment means never having to face mandatory retirement! Whatever you choose, remember that you have many, many life skills you can leverage.

f. Increase Retirement Savings as You Can. There is good news from the US government. Believe it or not, Uncle Sam has created incentives for you to save in your later years. Provisions for retirement planning procrastinators include “catch-up contributions.” The catch-up contribution provides for accelerated retirement savings after age 50. The limit for employees aged 50 and over who take part in 401(k), 403(b), most 457 plans and the federal government’s Thrift Savings Plan (2019) is $6,000. The catch-up contribution limit for individuals aged 50 and over to the Individual Retirement Plan is $1,000. To learn more follow the link to IR-2018-211 released by the Internal Revenue Service on November 1, 2018.

g. Reduce your Medical Expenses with Medicare. If you are within three months of your 65th birthday, you can sign up for Medicare. Medicare is the national health insurance program for people age 65 or older. Part A helps pay for inpatient care in a hospital or skilled nursing facility. Part B helps pay for doctors’ services and many other medical services. Most people age 65 or older are eligible for free Medicare hospital insurance (Part A) if they have worked and paid Medicare taxes long enough. You should sign up for Medicare hospital insurance (Part A)  3 months before your 65th birthday.  Sign up even if you do not want to begin receiving retirement benefits at that time. Anyone who is eligible for free Medicare hospital insurance (Part A) can also enroll in Medicare medical insurance (Part B).  You enroll in part B by paying a monthly premium. Some beneficiaries with higher incomes will pay a higher monthly Part B premium. If you do not choose to enroll in Medicare Part B and then decide to do so later, your coverage may be delayed and you may have to pay a higher monthly premium. To learn more about Medicare, follow this link to the Social Security Administration’s Medicare Page

h. Postpone Income and Required Minimum Distributions. Retirees who reach the age of 70 and one-half, have until April 1 of the next year to take their first Required Minimum Distribution (RMD) from their qualified retirement plan(s).  They have until the next December 31 to take their second distribution. Those individuals whose employer retirement plans allow it and who may continue to work after their 70th birthdays may wait until the year they retire to take their first Required Minimum Distribution. For more on this topic see the IRS Topic Page on Required Minimum Distributions

i. Use a Qualified Longevity Annuity Contract (QLAC) to Cover Income Needs in Later Retirement Years. For many, retirement funds are limited. If you are concerned about outliving your retirement assets, a QLAC is a great way of assuring yourself income later in retirement.  QLAC income must begin before you reach your 85th birthday but can last for the rest of your life. Click here to watch a seminar by QLACguru Ray Ryan describing this strategy then try our Failsafe (sm) Maximize Income Calculator to see how this strategy might work for you.

j. Mark your Calendar. Retirement is not a single event, but a process to be managed. To get started, follow the link to Calculate the important future dates of your retirement. Start studying your options and setting goals.  Be prepared to address each of the milestones as they arise at age 50, 55, 62, 65, 70 and 70 and one-half. 

Once you’ve done this homework, it may be time to hire on a financial advisor to help you grow your assets. But pick her or him carefully. Like Charles Barkley, you need to, “take the shame out of your game.”   Never allow a prospective advisor to ridicule the size of your portfolio. If he or she does, find another who won't.

After all, it’s not about what you have now, but what you can have in the future.  

Welcome to the next 30 years of your life!


Who Should Buy a QLAC (And Who Should Not?)

 Introduction

Who should consider buying a Qualified Longevity Annuity Contract (a “QLAC”)?  Who should not? 

A QLAC is a general account annuity that meets tests established by the Internal Revenue Service (“IRS”) in 2014.  The QLAC’s start date can be as late as the buyer’s 85th birthday.  The annuity payments continue for the life of the buyer (or the buyer and spouse). In this respect, the distributions are somewhat like social security benefits, except they start later. A QLAC premium (A Cap is described below) is withdrawn from a traditional IRA[1] without triggering a taxable distribution.  The IRA asset account is reduced by the premium distribution for purposes of computing the Required Minimum Distribution beginning at age 70½.  Because the QLAC premium distribution was not taxed, the QLAC annuity payments are all taxable upon receipt.  (Please try our RMD and QLAC annuity benefit calculator to see how this works.)

Why Not Buy a QLAC?

At the latest, planning for retirement should begin in one’s early sixties or at least sometime during the decade after that. Some people will not be concerned about running out of savings during their retirements.  Below are examples of persons who are unlikely to be QLAC buyers:

  • A beneficiary of a defined benefit plan that provides a large, fixed benefit for life;
  • An owner of defined contribution plans (401(k)s, IRAs, etc.) with combined asset balances more than $1.5 million;
  • An investor with a portfolio of assets that generate adequate income to meet retirement living expenses;
  • An individual whose retirement planning focus is about to whom her estate will be distributed; and
  • A person with a limited life expectancy due to a disability or illness.

It is hard to imagine any of the above persons buying a QLAC unless their focus is purely on tax deferral.  

Who Should Consider Buying a QLAC?

There are many more who should consider a QLAC in their retirement planning. Examples of people who look into a QLAC include:

  • An owner of defined contribution plans (e.g., 401(k)s, IRAs) with combined asset balances less than $1.5 million and who has no defined retirement benefits;
  • Someone concerned about becoming a burden to his or her children during retirement; 
  • A taxpayer whose social security benefits will be a material part of his or her retirement income;
  • A person with no assets outside a home and defined contribution savings; and
  • Someone in good health and with a family history of longevity.

 Fear of out-living one’s assets is the common concern of people in this second group.   Social security benefits, in of themselves, fall short of their living cost in retirement. Further, most do not want to ask for financial help from their children or other relatives.   As a result, they want to find a way to make their savings last for life.

A QLAC addresses this concern by creating a lifetime cash flow starting before age 85. With a QLAC purchased say 15 years earlier, the annual benefit can equal anywhere from 25% to 35% of the premium.

To date, QLACs sales have not caught up to the need in the marketplace. Why?  The product is less than four years old. Many future and current retirees are not aware that QLACs exist.  Others have heard of QLACs but from a party with a vested interest in maintaining funds under management who have made a negative comment.  Below are criticisms and rebuttals.

Life Expectancy

Here, an argument is made that a retiree can make his funds last for her life expectancy. As previously noted, projected mortality is part of the criteria in deciding whether a person is a QLAC candidate. People with terminal diseases have short life horizons. Others, with less cloudy futures, ask, “How long can I expect to live?” The only way to answer the question is to look at an actuarial table. Still, it is essential to look at the right table.

          2016 Table for a 65-Year-Old  Sex                    Life Expectancy

          Social Security Administration      Female             21.6 years (i.e., age 86.6)

          SOA Annuity Table for 2016          Female             25.1 years (i.e., age 90.1)

For retirees with savings, the Society of Actuaries table is the right choice.  Longevity has been shown to correlate with income and savings.  The Social Security table includes low-income earners and those who have failed to save. The Society of Actuaries table focuses on a more narrow mix.

The definition of, “Life Expectancy” is also important.  The term does not mean that a group of like-aged (a “cohort”) females will all die when they reach their life expectancy (e.g.,. age 90).   Instead, it means that of an original cohort, 50% of the group will be deceased and 50% will be alive when the survivors reach age 90.  Further, the Society of Actuaries predicts that at age 100 10% of the original cohort (i.e., 20% of those alive at age 90) will still be with us.  At age 105, about 1% will still be living.

Of course, on average males die before females. The Society of Actuaries predicts a male age 65 has a life expectancy of about 23 years.  The slope of the male mortality curve follows the female curve – 10% of the males make it to age 98. 

Life expectancy increases when the actuaries compute the survival probability for at least one of a married couple (born on the same day).  At age 65, that life expectancy becomes 29 years or age 94.

So, it is incorrect to predict that savings need only last to one’s life expectancy.   There is a reasonable chance that each of us may live ten years or more past our actuarial life expectancy.  Indeed, life expectancy has been growing and will continue to increase as medical treatments improve.  No matter how long it may be, providing for the tail end of life is what a QLAC is all about.

'Bad Investment' or Good Insurance?

Some money managers have branded a QLAC (and other life annuities) as bad investments. Still, a QLAC is not an investment – it is an insurance contract.  It pays no matter how long you live.  It does not pay after you die, i.e., when you no longer need the money.

Analogies abound. Social security is an example, although it is a mandatory government-sponsored plan.  On every payday, the employee and the employer pay into the social security trust fund.  After retirement (for social security purposes), each month a social security distribution is paid to the former employee – until he or she dies.  If an individual dies before benefit eligibility, their estate receives nothing – there is no refund of social security taxes previously paid to the government.

The same logic applies to defined benefit pension plans sponsored by private employers.  The plan sponsor contributes to the pension plan fund, and after retirement, the program pays a scheduled benefit – until he dies. An early death does not trigger a plan refund to the employer or the employee.

To summarize, a QLAC converts a portion of retirement savings from a defined contribution plan into a defined benefit plan. That conversion is what creates peace of mind for QLAC buyers - they have covered their late in life living costs no matter how long they live.

Early Death Refund

Unlike social security or a defined benefit pension plan, QLAC buyers can elect a Return of Premium (“ROP”) policy option.  This election provides that when a beneficiary dies, the cumulative distributions have to equal at least the premium paid.  For example, assume a QLAC premium of $20,500 and a scheduled benefit of $5,000 per year.  If the QLAC owner dies after collecting two years of $5,000 ten, then his or her estate will receive a ROP check for $10,500. 

There is an intuitive appeal to getting your money back with a ROP election. Still, the annuity benefit amount is reduced when a ROP election is made. It pays to examine annuity benefits with and without ROP to examine the tradeoffs.  Remember, a QLAC is about not being a burden on your children – a QLAC is not about creating an estate for children to inherit.

'Equities Are Better?'

From time to time, a money manager may argue that the stock market’s long-term rate of return is 10%.  For example, they will assume an annual 10% return on savings (the return rate does not apply to a QLAC) and the same retirement distributions with or without a QLAC. The basket without a QLAC will out-perform the basket with a QLAC.  The problem with this analysis is that the money manager will not and cannot give the IRA owner a guarantee that his recommended investments will generate a consistent 10% rate of return. Equities can be volatile – up and down. Long-term averages do not pay bills when the stock market declines 10% or 20% in a year of retirement. (Please see our article about the challenges of Sequence Risk for more on this concern.)


Insurance is a product for people who cannot afford a given risk or loss.  A car owner buys collision insurance because she cannot afford to replace her car. A QLAC buyer is doing the same thing – she cannot afford the loss of income in her later life.

No QLAC Surrender – Longevity vs. Liquidity

The IRS QLAC regulations state that the policy cannot have a surrender value.  The QLAC contract is irrevocable.  Once the premium is paid and the contract is delivered, there is no going back.  While reducing the flexibility of the contract for the buyer, this provision enables the carrier actuaries to create the highest payouts.  If the risk of surrender were a factor, the annuity payments would be much lower. (Consider the effect of the ROP election discussed above.)

To be sure, a QLAC is not a liquid asset.  A QLAC should not be used to fund discretionary spending. Instead, the focus should be on funding the projected annual cost of living.

Also, note that the IRS created a maximum lifetime QLAC premium per participant.  The QLAC premium(s) cannot exceed the lesser of $130,000 or 25% of the IRA fair market value (the “Cap”).  After a QLAC premium withdrawal, 75% or more of their IRA assets remain to invest in stock or bonds. To meet living expenses, the owner can withdraw from the IRA before the QLAC annuity start date.  For most retirees, these withdrawals can equal the future QLAC annuity amount. Also, the withdrawals can continue until the QLAC annuity start date[2].

Carrier Ratings & Persistency

Insurance companies issue QLAC contracts.  After the initial deferral period of 10 to 20 years, the underwriter will be paying benefits for decades after that.  This payment stream is like a corporation issuing a bond for 30 to 40 years, except there is no defined termination date with a QLAC. 

How secure is the carrier’s promise to pay? There are over a dozen top insurance companies that offer QLACs.  Without exception, each one has a long history and has high industry ratings.  (See our carriers page to see the year founded and AM Best's ratings of leading QLAC carriers.)  Other than tax rules, there is no federal government oversight of the insurance industry. Instead, the states regulate and license the insurers.  The states collect premium taxes where the insurance companies do business.

To date, carrier bankruptcies have been rare. When a carrier did become insolvent in the past decades, the state’s insurance department took control of the company. During the rehabilitation, the regulators' primary goal is to protect the policy owners. Often, the solution is to move policies from the distressed company to another and stronger carrier.  Essentially, the state insurance regulators is a performance guarantor of the carrier’s they regulate.

Silk Out of Sow’s Ear

Unfortunately, the old saying -No Silk out of Sow’s Ear – applies to QLACs.  If there are minimal savings in someone’s IRA, there is no way to convert 25% of a small number into a big number.  There must be available savings to purchase a QLAC - which generates a useful future annuity.

If a person wants to buy an immediate annuity[3], a QLAC should not be on the shopping list.  QLACs are only available as deferred annuities. QLACs perform best when the deferral period is ten years or more. Also, QLACs shine when the annuity start date is on or after the 80th birthdate of a QLAC owner. Three-quarters of one’s savings should be able to get a person to their 80th birthday or later. The purpose of a QLAC is to insure against longevity risk.


Summary

A QLAC is not for the person with no concern about running out of assets or savings during his or her lifetime. He or she does not have a risk to insure.

A QLAC provides income certainty during the later years of retirement.  Its distributions are for life.  This deferred annuity typically starts at age 80 or after.  A QLAC premium can be funded by a traditional IRA without triggering taxation of the allowed withdrawal. The amount of withdrawal cannot exceed 25% of retirement assets.  The limit is $130,000.

Candidates for a QLAC are those individuals that may outlive their savings. Most QLAC buyers have a reasonable expectation to survive well into their late 80s or 90s.

Want to learn more? Check out our videos page to see additional QLACguru videos.  See our calculators page to develop an anonymous RMD calculation and estimated QLAC quote. Answer specific questions by going to our Knowledgebase page.  Visit our blogs page for in-depth articles on a variety of topics including how QLACs help with sequence Sequence Risk, how QLACs are similar to and different from Social Securitybest practices in buying a QLAC as well as many other topics. Free Consultation.  If you would like us to develop a free RMD analysis and illustration of how a QLAC might work for you, please click here.





[1] In addition to an IRA, other Internal Revenue Code accounts can be used to fund a QLAC.  These are known as 401(k), 403(b) and 457(b) tax-qualified savings accounts. Herein, references to an IRA are meant to include the other three tax-qualified accounts.  Further, a Keogh savings account is not eligible for a QLAC withdrawal.

[2] The projection assumption is that IRA investments do not lose money in any withdrawal year. Each year can show a zero rate of return and still provide adequate withdrawals as described above.

[3] When annuity distributions begin within 12 months of the premium payment, the annuity is labeled as “immediate.” 


Sequence Risk in Retirement

Summary

Retirees that are withdrawing assets from savings during retirement are particularly vulnerable to a year or years with market losses.  The name of this vulnerability is “Sequence Risk.”  Using examples, this article shows why and how “Sequence Risk” hurts retirees.  Also, the examples show how traditional countermeasures perform in today’s world.  Finally, there is a measure of how a Qualified Longevity Annuity Contract helps reverse the negative consequences of “Sequence Risk.”  Possibly even more important, we show how a QLAC also eliminates benefit longevity risk for the retiree.  She or he cannot outlive her or his respective savings with a QLAC.

Introduction

Is “Sequence Risk” a concern for those retirees who depend on their IRA and other defined contribution savings plans?  The answer is, yes -- particularly for those individuals that are concerned about outliving their savings. 

What is Sequence Risk?  It is the risks that during the early years of retirement, the invested savings will be subject to a market decline such that the losses will reduce the amount of long term retirement benefits available to the retiree.

An example will demonstrate this phenomenon.  Let us assume a retiree with an IRA account with $200,000 in it. He plans to withdraw $8,000 a year during his retirement.   Under the Alternative, I scenario, his rate of return equals his withdrawals[1].  As a result, his account balance remains unchanged during the years below.

 

Alternative I

Year

IRA Account

Rate of Return

Earnings

Benefit Withdrawal

Y/E Balance

1

$200,000

4%

$8,000

<$8,000>

$200,000

2

$200,000

4%

$8,000

<$8,000>

$200,000

3

$200,000

4%

$8,000

<$8,000>

$200,000

4

$200,000

4%

$8,000

<$8,000>

$200,000

 

Under Alternative II below, the individual retires in a year with a market correction of 20%.  In the following year, there is an additional 10% decline in value.  While in years 3 and 4, there is a bit of recovery, the retiree has lost almost 37% of his investment capital.   Even if his average rate of return comes back to 4%, it is highly unlikely that the Alternative II retiree will recover the lost $37.000.  As a result, his benefit withdrawal capacity is at risk while he ages.

 

Alternative II

Year

IRA Account

Rate of Return

Earnings

Benefit Withdrawal

Y/E Balance

1

$200,000

<20%>

<$40,000>

<$8,000>

$152,000

2

$152,000

<10%>

<$15,200>

<$8,000>

$128,800

3

$128,800

4.5%

$5,800

<$8,000>

$126,600

4

$126,600

6%

$7,600

<$8,000>

$126,200

 

In other words, because a Sequence Risk event took place in the first two years of retirement, he may well outlive his IRA savings.

Guarding Against Sequence Risk

Between 1973 and 2008, there were seven annual downturns that exceeded negative 10% in the S&P 500 index.  The average annual loss exceeds 20% for these seven loss years.  While the current stock market has enjoyed an extended and remarkable growth, significant corrections often follow such periods of stock appreciation.   Accordingly, Sequence Risk is as much of a concern today as it has been for any time in the past. 

Retirement planners have a variety of strategies to insulate and protect retirees from Sequence Risk:

  • Limit annual withdrawals to 4% of the remaining investment corpus;
  • Create a bond “ladder” - purchase of a series of bonds that mature annually and which fund the withdrawal needs of the retiree for a period of 7 or more years.  The non-bond assets are invested in equities.
  • Invest in bonds in proportion to one’s age.  In other words, a 70-year-old would invest 70% of his or her portfolio in bonds – the remainder in equities.

More recently, the Qualified Longevity Annuity Contract (“QLAC”) has become available and is a useful tool to reduce or eliminate the negative consequences of adverse market sequence event(s).

 

A Case Study

 

Examples are often the best way to see how a financial program works.  In this case, our IRA owner, Maria, has $200,000 in her IRA[2] at the calendar year end when she is 69. She will retire at 70 and wants her IRA to supplement her social security benefits. Together the two funds flow should equal or exceed her cost of living. During Maria’s retirement, she plans to invest the funds remaining in her IRA and wants to feel comfortable that she will not outlive her retirement assets.

 

Projecting Investment Returns

To project equity returns, our example looks at the S&P Index performance for the 10 years beginning October 1, 2007, and ending September 30, 2017. We assumed that the S&P Index returns are a reasonable surrogate for equity investing.   Also, this period conveniently begins with a sequential loss.  The fiscal returns for the year ended September 30, 2008, are a 24% loss.  The fiscal year ended September 30, 2017, enjoyed a 16% gain. The annualized rate of return was 5% for those ten years. To project returns from age 70 to 110, the same sequence of returns was repeated four times (the “S&P Forecast”).

Another illustration was prepared to assume a simple 5% return on assets in every year.  That way, we can measure the effect of adverse sequence experience.  Below is a table that compares the S&P Forecast and the constant 5% return. (To see the detailed projections behind these summaries, click on the related hyperlink in each of the tables below.)

Illustration

Burn-out Age[3]

Total Distributions

Average Annual Distribution

I. 5% Annual Return

104

$467,000

$13,331

II. S&P Forecast

92

$265,000

$11,287

 

There is a significant detriment embedded in the adverse sequence experience of the S&P Forecast.  Losing 24% in the first year is never made up by 17% and 16% returns in later years.  The S&P Forecast runs out assets in 22 years – the 5% annual return alternative lasts another 12 years – more than 50% additional years.  Sequence Risk, indeed, matters.  See Graphic 1.


Next, we wanted to see what relief bond investments might offer.  Yields today on bond purchases are low.  We looked to current returns in the two most substantial bond funds for guidance: 

Name

ETF Symbol

Total Assets

30-Day SEC Yield

Vanguard Total Bond Market

BND

$36.9 Billion

2.65%

iShares Core US Aggregate Bond

AGG

$52.3 Billion

2.37%

 

We also noted that 5 year and shorter Treasury notes all have returns less than 1%.  To do a modified bond ladder, year one bond yields were assumed to increase 1% each year to equal 3% in the seventh year. Thereafter, the bond yields were set at 3% each year.  These bond return assumptions are high to avoid any bias in favor of the equity return assumptions.

John Bogle, the founder of Vanguard, is a strong proponent of holding bonds in an investment portfolio.  His recommended percentage of bond holdings ranges from 40% to 75%, depending on the age of the investor.  Accordingly, we prepared illustrations where a participant invested in a combination of bonds and the S&P (the “Combo” investment).  The investment ratio is a constant 70% bonds and 30% S&P index – both as described above.

Withdrawals from the IRA

Our retiree, Maria, wants to know how much she can withdraw from her IRA and how long her IRA will provide adequate income to supplement her social security benefits.   Her calculations suggest that $9,000 of annual withdrawals is a minimum for her needs.  Since the Federal Reserve Bank is targeting a 2% rate of inflation – ideally, her withdrawals can include an annual increase for inflation. Let’s look at three withdrawal scenarios:

  • The retiree withdraws 4% of prior year end’s IRA assets each year.
  • The annual withdrawal equals $9,000 each year plus any amount needed to equal the RMD.
  • The withdrawal equals $9,000 plus a 2% annual growth rate (RMD is not triggered).

 

Strategies for Limiting Sequential Risk

Let’s see if the 4% rule and the Combo help to offset the loss of benefits due to Sequential Risk.

The 4% withdrawal rate enables the assets to last to age 110 and beyond. Still, between ages 71 and 77 inclusive, the 4% amount is less than $8,000 per annual – far less than the needs of Maria.  Starting at age 73, the 4% rule is not relevant. (See the Appendix, Illustration III.)  The RMD amount is larger.  When it comes to offsetting Sequential Risk, the 4% rule has little to offer an IRA owner. Merely taking the RMD required each year will give an equivalent and volatile result. 

The Combo approach certainly reduces the volatility of Maria’s investment returns.  Also, the Combo investment has more assets in the early years than a straight S&P Forecast.  The RMDs are less than the Combo withdrawals in the early years – allowing the Combo approach to compound its asset basis while the S&P Forecast is struggling to catch up.   Still, the Combo investment approach only adds one more year of distributions.  

See the chart below:


Illustration - $9,000 Fixed

Burn-out Age3

Total Withdrawals

Average Annual Withdrawal

IV. Combo Return

104

$319,000

$9,124

V. S&P Forecast

103

$311,000

$9,145

 

In both investment alternatives above, the Average Annual Withdrawals are higher than $9,000.  This arises because in various years after age 85 the RMD is higher than the planned for withdrawal of $9,000.

If Maria adds 2% inflation to her annual withdrawals, her assets run out 11 years before restricting withdrawals to a flat $9,000.  Also, her scheduled withdrawals will always exceed RMD.  See Graphic 2 and the chart below it.



Illustration - $9,000 Plus 2% Inflation

Burn-out Age3

Total Withdrawals

Average Annual Withdrawal

VI. Combo Return

93

$274,000

$11,408

II. S&P Forecast

92

$260,000

$11,287

 

Qualified Longevity Annuity Contract (“QLAC”)

Maria conceded that mixing bonds and equities can protect against Sequence Risk of a straight equity investment. Still, she had hoped for more than one or two additional benefit years.  As a result, Maria decided to see what if any benefit a QLAC might offer.

Her research revealed that if she buys a QLAC with a start date of age 85, the lifetime annual annuity equals 36.5% of the premium.   That single life annuity will be $12,775 per annum if she pays a premium of $35,000.  Since the legal limit on premiums is 25% of her IRA balance of $200,000 (i.e., $50,000), Maria is well within the legal parameters.   Maria can withdraw the $35,000 from her IRA without it being treated as taxable to her.  Also, the withdrawal reduces the IRA assets used to compute the RMD of her residual IRA balance.

Maria looked at a QLAC premium of $35,000 coupled with her preferred withdrawal scenario ($9,000 plus 2% inflation). Even after reducing the IRA account by the QLAC premium, the IRA account still has assets after 15 years of benefit withdrawals. The Combo has $45,000, and of course, the S&P Forecast has less - $10,000.  After age 84, these IRA balance amounts are then amortized by the RMD requirements and are in addition to $12,775 QLAC annuity beginning at age 85. Below is a summary chart of the performance of the QLAC choices:  

 

QLAC Illustration - $9,000 Plus 2% Inflation

Burn-out Age3

Total Withdrawals Thru Age 110

Average Annual Withdrawal

VII. Combo Return

Never

$554,000

$13,523

VIII. S&P Forecast

Never

$504,000

$12,283

 

Again with a QLAC, the Combo route is able to generate higher annual benefits than pure equity returns where adverse Sequence Risk is experienced.

Still, what Maria finds attractive is that she does not have to reduce her targeted income needs to purchase a QLAC.  With a QLAC, she can still withdraw amounts dictated by the $9,000 plus 2% formula.   By year 15 (when she is 84 years old), her inflated withdrawal will increase to $11,875.  Starting at age 85, the QLAC annuity kicks in to pay her $12,775 per annum plus the RMDs triggered by the assets remaining in the IRA. The $12,775 annuity will last as long as she does.  See Graphic 3.


Studying these results, Maria recognizes that her focus on Sequence Risk was an embedded concern that she would outlive her assets.  Mixing debt and equity investments can reduce Sequence Risk, but it will do little to address longevity risk – unless she dies before 90 or substantially reduces her lifestyle and expenditures in retirement.  With a QLAC purchase, she can convert the tail end of her retirement into a defined benefit plan where it is not possible to run out of benefits.  Even better, she can create a plan (with a QLAC) where the average annual withdrawals are projected to exceed those of an IRA without a QLAC.

For Maria, a QLAC makes a lot of sense – it helps to reduce Sequence Risk and eliminates longevity risk.  It meets her retirement planning objectives.

Want to learn more? Check out our videos page to see additional QLACguru videos.  See our calculators page to develop an anonymous RMD calculation and estimated QLAC quote. Answer specific questions by going to our Knowledgebase pageVisit our blogs page for in-depth articles on a variety of topics including how, how QLACs are similar to and different from Social Securitybest practices in buying a QLAC as well as many other topics. Free Consultation.  If you would like us to develop a free RMD analysis and illustration of how a QLAC might work for you, please click here.



[1] For simplicity purposes, the example ignores the IRA Required Minimum Distribution (“RMDs”) requirements of the IRS.

[2] A traditional IRA is assumed and accordingly, is subject to the RMD distribution rules.

[3]  The “Burn-out Age” occurs when the IRA beneficiary can no longer withdraw the projected benefit.  Smaller amounts may be payable for one or two years after the “Burn-out Age”.

 


A Women Over 60? Why QLACs May Be Your Best Friend

By Betsy Ryan and Ron Ryan

Are you old enough to remember, “Diamonds Are a Girl’s Best Friend?” The song is from the 1953 Musical, Gentlemen Prefer Blonds starring Marilyn Monroe?[1]

The French are glad to die for love.
They delight in fighting duels.
But I prefer a man who lives
And gives expensive jewels!
A kiss on the hand.
May be quite continental,
But diamonds are a girl's best friend!

A kiss may be grand,
But it won't pay the rental
On your humble flat
Or help you at the automat.


Source: Marilyn Monroe - Diamonds Are A Girls Best Friend Lyrics | MetroLyrics 

Here is why these lyrics are relevant even today – more than 50 years later.  The average life span in America is growing, and women are living much longer than men.  A 2014 longevity study[i] predicts a 60-year-old woman has a 32 percent chance of surviving to age 90. If a woman celebrates the 80th birthday, there is a 42 percent chance of living to 90! A husband’s survival rates are much lower than those of his like-aged wife.  A woman's chances of outliving her husband at age 60 are a whopping 57 percent. [ii] Social Security actuaries developed these observations from the entire social security database, which includes the whole United States population.  If you are a 60-year-old woman who does not smoke and are generally in good health, the probability of outliving your spouse is even higher than the above percentages.

How to pay for all those Golden Years? 

In retirement, a QLACs may be - to borrow from the song -  “A girl’s best friend.” Here are a few basics:

  • A QLAC stands for Qualified Longevity Annuity Contract.
  • Available only since 2014, a QLAC provides a pension-like stream of annuity payments in the later years of retirement. 
  • A woman may buy a QLAC today, lock in lifetime monthly income starting at a future date of her choosing.
  • A QLAC allows her to defer benefit payments until age 75, 80 or 85 -- or anywhere between. The longer she waits for the payout, the higher the QLAC’s benefit payment. 
  • An IRA owner may buy a QLAC with IRA assets without incurring a tax penalty. She can use the lesser of 25% percent of IRA assets or $125,000 out of her qualified retirement account to buy a QLAC.  (For 2018 and after, the maximum QLAC limit increases from $125,000 to $130,000.)
  • The IRS calculates this limit per individual taxpayer. If both a woman and her spouse have IRAs, each may buy a QLAC.
  • Until benefit payments start, no required minimum distributions are payable on the QLAC assets. So, she defers taxes on whatever money she put into her QLAC.

Once the annuity starts, QLAC benefits will continue for as long as she lives.    Benefits will continue while she is alive -- even if she lives to age 100 or older. 

R-E-S-P-E-C-T Might Mean Q-L-A-C!

High net worth individuals do not often worry about running out of assets in retirement. They can use the so-called  ‘four percent rule’ to liquidate their portfolios.   With smaller portfolios (e.g., IRA assets between $100,000 and 1 million dollars), that 4% rule does not make sense. A Qualified Longevity Annuity Contract is an excellent alternative strategy. A QLAC can provide a reliable stream of payments throughout even the most extended retirement.  Indeed, a QLAC can outlast diamonds, gold, and stocks, and bonds, and (probably) your husband.  Although they have different start dates, social security and QLACs share the common attribute of payments for life to the beneficiary – even if that period is the next thirty or forty years.  

Now, before you go out and buy a QLAC, here are a few things to consider:

  • A QLAC is irrevocable. Once purchased, you cannot get the money back from a QLAC -- until it compensates you in the form of benefits. To make sure you get your premium amount back, you can buy the QLAC with a so-called “return of premium" rider.  A return of premium rider is a kind of death benefit. The benefit will pay your estate any unreturned premium in the event of death. Be aware that such riders come with a reduction of lifetime benefits.
  • A QLAC Payout Is Fixed. One of the main advantages of a QLAC is that it allows you to know today what you will receive in the future. If you think inflation is a risk, you can buy a rider that guards against inflation.  As with a return of premium rider, a cost/benefit tradeoff exists for the Cost of Living Adjustment (COLA) rider as well.  You should study the alternatives.
  • A QLAC is a life annuity issued by an insurance company.  Because of the “for life” feature, a QLAC is more like social security benefits than it is like investing in stocks or bonds.  As a result, the rates of return are low if the beneficiary dies early and high if the beneficiary is long-lived. One comprehensive study has shown that life annuities, in general, are the best choice for individuals funding for their essential living expenses for the duration of their retirement. The stock or bond alternatives run “sequence risk” or the devastating outcome of incurring investment losses in the early years of retirement.  Stocks and bonds are appropriate for individuals funding lifestyles (e.g., around the world trip), legacies for heirs and buffer assets for the unexpected. A QLAC is an assurance that there will always be a check to cover one's retirement living expenses.
  • A QLAC reduces your asset-based advisor’s compensation. Is your retirement portfolio managed by someone compensated based on assets under management? If so, don’t expect that manager to support the idea of a QLAC. A QLAC will reduce their compensation by up to 25 percent.  Be sure to review a QLAC investment with a genuinely objective advisor.
  • As with Diamonds, Be Sure to Choose A Real One! A QLAC is a type of Deferred Income Annuity, but not all Deferred Income Annuities are QLACs. Also, a QLAC is not a variable or index annuity.  Both those types of annuity have their performance tied to the stock and bond markets.  (Variable and Index annuities pay much higher compensation to the seller.)  A QLAC is designed and sold by the life insurance carrier as a Qualified Longevity Annuity Contract.

The QLAC was created by IRS regulation to help seniors who are living longer. Below is a summary of QLAC required features:

  • Must be a life annuity – single or joint with a spouse;
  • Must be a deferred annuity starting no later than age 85;
  • Only defined contribution account funds (e.g., IRA) may be used;
  • Roth accounts and large pension plans cannot participate;
  • The 25%/$125,000 premium limit applies to each;
  • No surrender values, but Return of Premium election is allowed;
  • The annuity cannot be variable or otherwise indexed to a market;
  • Annuity benefits are backed by the good faith and credit of carrier;
  • Up to the specified limited noted above, withdrawal from the retirement account to fund the QLAC (e.g., IRA) is not taxed;
  • Withdrawals do reduce plan (e.g., IRA) assets for RMD computations;
  • QLAC Annuity deferred payments are 100% taxed when received, but this will occur in the future when you are likely to have less income.

QLACs and Diamonds?

Every woman over sixty may want to consider a new ‘best friend’ in addition to her diamonds. She should take a proactive look at retirement assets with an eye for the long term. Later in life, a QLAC may be a “girl’s best friend.”

 

Want to learn more? Check out our videos page to see additional QLACguru videos.  See our calculators page to develop an anonymous RMD calculation and estimated QLAC quote. Answer specific questions by going to our Knowledgebase page.  Visit our blogs page for in-depth articles on a variety of topics including how QLACs help with sequence Sequence Risk, how QLACs are similar to and different from Social Securitybest practices in buying a QLAC as well as many other topics. Free Consultation.  If you would like us to develop a free RMD analysis and illustration of how a QLAC might work for you, please click here.

   

 

[i] See https://www.ssa.gov/OACT/NOTES/as120/LifeTables_Body.html

[ii] See http://www.numericalexample.com/index.php?view=article&id=95



[1] Modern entertainers from Madonna to Beyoncé have borrowed from this iconic production.  While no doubt anachronistic, the song does raise a vital challenge -- how to pay the rent in our later years!  

 


Many people are surprised to learn that they have to take Required Minimum Distributions (“RMDs”) when they reach the age of 70½.  The RMD rule applies to IRS sanctioned retirement savings plans (“Plan” or “Plans”).  These Plans have names like an IRA, a 401(k), 403(b), 457(b) and other acronyms.  Contributions to these traditional retirement savings Plans are made with “pre-tax” dollars – an individual taxpayer’s Plan contributions are reductions in that person’s gross taxable income.  Also, an employer’s Plan contributions are not taxable to the employee.  Even better, assets in each Plan can grow free of income tax.  Of course, the IRS eventually wants tax revenue. So, all distributions from these traditional retirement Plans are taxable to the Plan beneficiary/recipient. 

Some retirees can maintain their lifestyles without withdrawals from their IRA or similar Plan.  Given the wealth-creating power of compounding returns without tax, these retirees often want to allow their Plan assets to grow tax-free as long as possible - without taxed distributions.  Unfortunately, the tax rules specify an annual Required Minimum Distribution (“RMD”) for all “Traditional” Plans.  The RMD rule applies once a person reaches age 70½ and each year after that.   An RMD distribution shortfall is subject to a 50% penalty as well as the regular income tax.

Careful tax planning can assure that there are annual withdrawals from a Plan at least equal to the RMD.  But can a taxpayer reduce or eliminate the RMD exposure to maximize the benefit of tax-free compounding?  The answer is yes, but it takes planning and the right facts.  Below are some approaches.

ROTH 401(K) PLAN

Plans with a “Roth” in their title have tax treatments that differ from Traditional Plans.  Contributions are treated as taxable income or not deductible, but distributions are tax exempt.  Many if not most employers (offering 401(k) plans) give the employee the option of having a Roth or a Traditional 401(k) Plan.  As a result, today there are many billions of dollars in assets held in Roth 401(k) plans.   The RMD rules are the same for both Traditional and Roth 401(k) Plans. 

Here, there is a simple solution to the RMD problem.  A Roth IRA has no RMD requirement ( the Traditional IRA is subject to RMD).  A Roth 401(k) plan can be rolled over into a Roth IRA without creating taxable income.  Absent some extraneous factor; all Roth plans should be transferred to a Roth IRA before the RMD rules apply.  Of course, the rollover will have to occur when an employee has the authority to transfer the account, usually after leaving employment with the plan sponsor.

TRADITIONAL PLAN ROLLOVER

Can a person roll over to a Roth IRA if he or she holds assets in a Traditional Plan (e.g., 401(k) or IRA)?  The short answer is “yes,” but there are two hurdles to a rollover from Traditional to Roth:

  • The rollover amount is taxed as ordinary income in the rollover year.
  • No distributions from the Roth IRA can occur for five years after the rollover.

The rollover amount can be less than the total Traditional Plan asset balance.  Any distributions needed for the five years after the rollover should be held back in the Traditional Plan. After the fifth year, the Roth IRA is free to make some or no distributions to its beneficiary.

An individual’s tax situation dictates whether or not this rollover strategy makes sense.  For example, assume a person will be in a high tax rate at the rollover date and expects a low or no tax in a future distribution year.  A rollover in this example would be inappropriate.   The ideal time to do a rollover is in a year when an individual’s taxable income is unusually low.  Such a person might be between jobs, early retirement before benefits are paid, report deductible passive losses from real estate investments, etc.   Also, it is possible to plan multiple rollovers to multiple Roth IRAs over the years.  The rule is to do the rollover in a tax year when rates are low, or there are sufficient losses. Even more important – run the numbers and do a sensitivity analysis on both assumed tax rates and investment rates of return.

Here is an important point.  If the rollover into a Roth IRA occurs when the RMD rules apply, an RMD distribution will still be required in the rollover year.

There is no age restriction on a Plan roll as far as income taxes.  Still, the Plan’s language must allow the event.   For more on how to manage lifetime income using a Roth IRA, see our blog article on the topic.  

PLAN TERMINATION

A simple way to avoid RMD is to terminate the Plan before the beneficiary reaches age 70½.  Generally, a penalty is triggered by a termination or Plan distribution before age 59½.  After age 59½, the beneficiary of a Traditional Plan is free to withdraw any amount so long as it equals or is greater than the RMD for that year. Withdrawal of all Plan assets will terminate the Plan.  Please recall that Traditional Plan withdrawals are taxed as ordinary income.

Just like with a rollover to a Roth IRA, distributions should be planned to occur in the year(s) when the Plan beneficiary has low or no other taxable income. So doing, the tax cost of the distribution(s) will be minimized.    Once received, the funds can be reinvested by the Plan beneficiary in his capacity as an individual investor.  The tax-advantaged choices are many – non-dividend paying stocks, deferred annuities (variable or general account), real estate, oil & gas, etc. Tax deferral depends upon the nature of the assets selected for re-investment.

A QLAC

If a person owns a Traditional Plan, the IRS has created a new type of qualified tax annuity – the Qualified Longevity Annuity Contract (“QLAC”).  The IRS authorized this new class of annuity contract in 2014 to help taxpayers of more modest means to assure themselves that their Plans would never run out of money.  Under the IRS rules, a QLAC must have the following attributes: 

  • The annuity must be deferred and not be an immediate annuity;
  • Once payments begin, the annuity is for the remainder of the beneficiary’s life;
  • The annuity must start no later than the owner’s 85th birthday;
  • The policy must be a “general account” insurance product – not variable;
  • The owner and a spouse may be joint beneficiaries;  and
  • The maximum QLAC premium is the lesser of $130,000 or 25% of Plan assets.  (The $ 130,000-lifetime limitation was increased to $130,000 from $125,000 on January 1, 2018, and will rise from time to time after that.)  
  • There are two significant benefits of buying a QLAC: 
  • Taxable income does not arise from a Plan withdrawal if used to pay a qualified QLAC premium;
  • The Plan assets are reduced by the premium withdrawal for computing RMD.

 It is important to recognize that a QLAC is an annuity, a form of insurance policy – not an investment contract.  A QLAC guarantees a fixed income for the life of the policy owner (and spouse, if elected).  There is also an available election that provides that the sum of all payouts must be equal to the premium paid.  Assume a QLAC was purchased for $125,000 with the annuity to begin at age eighty-five.  If the QLAC owner dies at age eighty, then his estate will receive $125,000, a refund of the premium paid.  (Without the return of premium election, there would not be benefits payable to the beneficiary’s estate ).  As a result,  a conservative analysis assumes that the QLAC return is 0% but never negative. On the other hand, the RMDs are reduced because the Plan assets are reduced by the distribution to pay the QLAC premium.  As a result, the beneficiary has more pre-tax dollars at work.  

The benefit of a Plan without a QLAC withdrawal is that there are more Plan assets which can grow tax-free inside the Plan – but higher RMDs.  Of course, without a QLAC, all the Plan assets are subject to investment risk.

Increased Plan distributions have distinct tax disadvantages.  Funds moved outside the Plan are taxed 100% as ordinary income - thereby reducing available re-investment assets.  Further, the remainder assets typically generate taxable income, further reducing asset growth. 

Once again, there is no one best answer concerning the above tradeoffs.   For each person, the right answer depends on the assumed tax rates, when the QLAC annuity begins, and the expected rates of return inside the Plan - as well as the rate of return on the invested distributions.  The QLAC can be an “investment” when the return of premium election is made.  As part of a portfolio of invested assets, the QLAC could be categorized as low or no risk while the assets in the Plan might be at incrementally higher risk than without the QLAC.  Finally, for many investors, there is a very important ‘sleep at night’ factor of knowing that a well-rated insurance carrier guarantees a certain part of future retirement income. 

CHARITABLE CONTRIBUTIONS

Once the RMD age is reached, a Traditional IRA can make a qualified charitable contribution up to $100,000. (To take advantage of this option, other Traditional Plans need to transfer assets to the IRA.) That contribution is treated as an RMD distribution for purposes of the RMD test but is not treated as taxable income to the Plan beneficiary.   For all intents and purposes, the IRS is assuming that the distribution’s imputed income and charitable deduction offset and neither need be reported.

Of course, instead of having the IRA make the contribution, a beneficiary could take a $100,000 distribution and turn around and make a $100,000 charitable gift.  For high-income individuals, there are disadvantages to this alternative approach.  First, the individual’s Adjusted Gross Income (“AGI”) will be increased.  A variety of tax rates kick in at higher levels of AGI.  Also, some personal deductions are limited as AGI becomes higher.   For example, itemized deductions (i.e., contributions to charities) are reduced when AGI exceeds certain thresholds (e.g., $155,650 if married filing separately).  For most high-income taxpayers, the net effect will be more taxes to pay under this second approach than if the beneficiary had simply instructed the IRA to make the charitable contribution.

A beneficiary’s charitable intent is the starting point of this RMD minimization strategy.  Having the IRA fulfill that intent is just a better way. Note that the $100,000 is a maximum only.  For Plans with less than $2.5 million in assets, typically, the RMD amounts will be less than the $100,000.   While a Plan could limit its charitable transfer to RMD, the charitable gift by the IRA could be less or more than the RMD – just not more than $100,000 in a given year.

An interesting approach might be to use a QLAC to reduce the Plan assets and after that, dedicate the reduced RMD to charitable gifting.

ANNUITIES

Buying an annuity such as an Immediate or Deferred annuity inside a Traditional Plan may achieve planning objectives, but these purchases are not a means of reducing RMD.  (A QLAC is not a traditional annuity and should not be confused with the annuity contracts described below for this discussion.) 

An Immediate annuity (annuity payments begin within 12 months of the purchase date) distribution is often treated as a deemed RMD.  The annuity distribution is 100% taxable to the beneficiary.  The Immediate annuity is great for the person who seeks a risk-free return and lifetime income. 

A Deferred annuity (annuity payments begin after 12 months of the purchase date) has another issue.  Unlike an Immediate annuity, the Deferred annuity has a cash value designated by the annuity contract or imputed by the IRS.  As a result, RMD will be computed each year based on that cash value.  Sufficient liquid assets need to be held in the Plan but outside the Deferred Annuity to assure there are available distributions to cover the computed RMD.  Once the annuity begins its payments, the payouts are typically deemed equal to the RMD.  This approach offers little or no opportunity to defer RMD.

Traditional annuities are not vehicles to accumulate assets tax-free inside a Plan.  Any tax deferral inside the annuity becomes irrelevant when the asset is held inside a Traditional or a Roth Plan.  Avoiding RMD is a strategy to allow assets to grow tax-free typically for a future beneficiary.  Annuities are about providing secure lifetime cash flows to the Plan beneficiary.  

 SUMMARY

Avoiding or minimizing RMD is for future or current retirees who do not or will not need their savings inside a Traditional Plan. A Plan that buys an Immediate or Deferred Annuities will not help reduce the RMD and will likely reduce or eliminate residual assets at the end of the beneficiary’s life.

Good Planning tools include distributing Plan assets to buy a QLAC, moving some or all of the Plan assets into a Roth IRA, distributing Plan property at an opportune time and fulfilling charitable gifting via a traditional IRA. The QLAC has no tax toll charge on the transfer from a Plan, but it is limited in the percentage of assets that can be used to pay a QLAC premium.  Transfers from a Tradition Plan to a Roth IRA (or simply outside the Plan) are 100% taxed, but that tax can be managed by doing one or more transfers in low tax rate year(s).  Finally, making charitable gifts from an IRA reduces RMD and is tax efficient for high-income taxpayers.

There is not a perfect solution for all.  Instead, minimizing RMD requires thoughtful planning with a keen eye focused on the beneficiary’s objectives and not just tax minimization.

Want to learn more? Check out our videos page to see additional QLACguru videos.  See our calculators page to develop an anonymous RMD calculation and estimated QLAC quote. Answer specific questions by going to our Knowledgebase page.  Visit our blogs page for in-depth articles on a variety of topics including how QLACs help with sequence Sequence Risk, how QLACs are similar to and different from Social Securitybest practices in buying a QLAC as well as many other topics. Free Consultation.  If you would like us to develop a free RMD analysis and illustration of how a QLAC might work for you, please click here.



A  Failsafe Roth Plan

A FAILSAFE ROTH PLAN

In decades past, most employer pension plans fell into the category of a Defined Benefit Plan (“DB plan”).  That is, when an employee retired as a beneficiary of a DB Plan, he or she received a monthly payment for his or her retirement life span.  The DB plan payment amount was determined by formulas driven by the employee’s length of service and compensation while working for the employer.  The employee benefit was independent of the pension plan’s financial performance or the plan’s investments. 

Today, the numbers of DB Plans have declined dramatically and have been replaced by Defined Contribution Plans (“DC Plans”).  Defined benefits are not part of a Defined Contribution Plan – the available distributions from a DC Plan are determined by the magnitude of contributions and the plan’s earnings.  Once a Defined Contribution Plan beneficiary retires, there are minimum withdrawal rules, but nothing that prevents a beneficiary from making withdrawals such that DC Plan assets are fully spent or depleted before that retiree dies.  The major shift from DB Plans to DC Plans in the USA coupled with lower average returns, poor savings rates, higher healthcare costs, and greater longevity has created a nation worried about running out of money during retirement.   

In a prior blog article, we described an approach that guarantees that an IRA Plan beneficiary will not outlive his or her savings.  That approach is the “Failsafe Strategy.”  To implement the strategy, a person with a traditional Individual Retirement Account (“IRA”) (or other qualified DC Plan) divides his IRA assets into two “buckets.”  The first bucket distributes a fixed annual amount from the IRA from the start of retirement to a future annuity start date (e.g., between ages 70 to 85). At the end of the first bucket’s tenure, there can be few or no assets in the IRA. The second bucket is a Qualified Longevity Annuity Contract (“QLAC”) that pays an annual benefit (e.g., starting at age 85) for life.  The tax rules allow a withdrawal from a traditional IRA Plan to be tax exempt if invested in a QLAC.  Accordingly, the QLAC premium amount was withdrawn from the IRA before or at age 70 and the QLAC lifetime annuity benefits were determined at the purchase date.  Click here to see a calculator we developed especially for developing this kind of plan.

ROTH PLANS – NEW KIDS ON THE BLOCK

Traditional DC Plans come in a variety flavors and scents – examples include an IRA, a 401(k), a 403(b), a 457(b), a SEP IRA, a Keogh, and a SIMPLE plan.  Each of these plans shares common attributes:

·         Each has its definition of who can contribute and the contribution limits of the plan;

·         The contribution is with pre-tax compensation or earnings;

·         Retirement distributions from the plan are 100% taxable income to the beneficiary.

In 1997, Roth IRAs became a new Defined Contribution Plan option.  Next, in 2001 Congress created Roth 401(k), Roth 457(b) and Roth 403(b) DC Plans. The Roth DC Plans were made permanent in 2006.  Since then, the plan’s popularity has grown.  For example, there were over $500 billion in Roth IRA assets in 2013.

 So, what is different about a Roth versus a traditional DC Plan?  

·         The contributions to the Roth plan are with after-tax compensation or earnings;

·         Retirement distributions from the plan are 100% tax-exempt to the beneficiary.

The income earned inside the Roth DC Plan is also tax exempt – just like a traditional Defined Contribution Plan.  Generally, the implementation rules are the same.  For example, both Roth and traditional 401(k) plans are subject to the same Required Minimum Distribution (“RMD”) rules after the plan beneficiary reaches age 70½.  There are important exceptions.  Here is one: a traditional IRA is subject to the IRS RMD requirements, but a Roth IRA is not.  This is an essential difference that enables us to create a Failsafe Roth strategy.

The 2014 QLAC regulations specifically exclude any distributions from a Roth Defined Contribution Plan.  Of course, any distribution from the Roth Plan is already tax exempt.  As a result, a distribution can be used by the beneficiary to buy any annuity.   The problem is that distributions from that annuity, purchased outside of the Roth, will no longer be fully tax exempt.  Instead, each distribution will include a return of the premium cost (which is not taxed) and the earnings that occurred inside the annuity (which is taxed).

The problem is solved by having a Roth IRA buy an annuity and be its beneficiary.  In other words, the Roth IRA will divide its assets into two buckets.  The first bucket will distribute cash to the beneficiary over a predetermined period – just like a traditional IRA.  The second bucket is used to buy a deferred annuity with a distribution start date (e.g., age 85) just like with a QLAC annuity.   Unlike a traditional IRA that distributes funds out of the plan to purchase a QLAC, The Roth IRA plan is the owner and beneficiary of the annuity.  Annuity benefits are paid to the Roth IRA, which in turn, can distribute the cash receipts to the Roth IRA beneficiary.  So doing, the Roth IRA distributions are fully tax exempt.  By using a Roth DC plan to purchase the annuity, a beneficiary is not constrained by the $125,000 cap ($130,000 starting in 2018) which applies to a QLAC purchase.

An individual may have a Roth 401(k) plan and not a Roth IRA – or have both.  To be sure, 401(k) plans have larger contribution limits.  As a result, an individual’s Roth 401(k) plan can accumulate more savings during his or her working years than a Roth IRA. It is important to recognize that employer 401(k) plans are not uniform.  Today, more than half employer-sponsored 401(k) plans allow an employee to elect either a Roth or a traditional plan.  

Many - if not most - plans require that when an employee resigns, he or she may (or is required to) “rollover” the plan assets into an IRA or another 401(k) plan.  Similarly, when an employee retires, there is a rollover requirement or option.  Also, employer-sponsored plans will be administered by a trustee (also, called a custodian) such as Principal Financial or Fidelity.    The investments available to the plan participant will be those approved by the employer from a list of investments often managed by the trustee’s related fund managers.  A dozen or fewer choices are typical.

When a rollover option or requirement happens, generally it makes sense to move the assets from the Roth 401(k) to a Roth IRA. (Note – rollovers done incorrectly can trigger tax and penalties.  IRS Publications 560, 575 and 590A are helpful reading.  Better yet, consult a tax expert before executing a rollover.)  Even though a transfer to another Roth 401(k) is also a tax-free transfer, remember that a Roth 401(k) plan is subject the RMD required distributions whereas a Roth IRA does not have an RMD requirement.   A non-IRA Roth DC plan could easily fail the RMD test if it holds both buckets – regular investment funds and an annuity.  Assuming there are same investment options, there is no advantage of a rollover to a Roth 401(k) versus a Roth IRA.

Here's another reason for moving to Roth IRA rather than to a Roth 401(k).  Before executing a rollover, the participant must choose a new trustee.  This is an important choice.  For example, Fidelity may offer a short list of annuities that underperform a long list of annuity choices at Principal.  The choice of a plan trustee is a choice of the kind of deferred annuity that is available.  It is important to note that Roth IRA trustees are available that allow “self-directed” investments by the beneficiary.   A self-directed Roth IRA has a truly independent trustee that is agnostic about the purchases selected by the participant. 

 Many of the insurance companies selling annuities will create a Roth IRA to receive the rollover proceeds earmarked to purchase that company’s annuity contract.   Once an annuity is targeted for purchase, it makes sense to ask the carrier if they offer the ability to create a Roth IRA to receive funds designated to buy their annuity.  Creating a new Roth IRA is a service offered for nominal or no cost. 

Please note that a Roth 401(k) rollover can be to more than one Roth IRA.   It is possible to have one Roth IRA to hold the assets to fund the first phase of retirement (i.e., the first bucket) and a second Roth IRA to hold the life annuity to fund the second phase of retirement (i.e., the second bucket).  Such a breakup might be motivated by selecting a plan sponsor with a good investment track record for the first bucket and using a self-directed plan or an insurance company trustee to acquire the second bucket’s deferred annuity.

SUMMARY

A Roth 401(k) (or a Roth IRA) can duplicate the same Failsafe strategy available to a traditional DC Plan that distributes funds to buy a QLAC annuity.  While there are a couple more steps, they are not complicated:

·         Determine the two phases of retirement funding;

·         Divide the Roth DC Plan assets into the two buckets of retirement assets;

·         Migrate  the  two buckets  of assets into one or more Roth IRAs;

·         Purchase a deferred life annuity in one Roth IRA;

·         Distribute bucket one assets during the first phase of retirement;

·         Distribute bucket two assets (annuity receipts) during the second phase of retirement.

Because the Roth IRA buys a life annuity, the participant collects income for however long he or she may live.  Accordingly, it is impossible to outlive one’s savings. 

Want to learn more? Check out our videos page to see additional QLACguru videos.  See our calculators page to develop an anonymous RMD calculation and estimated QLAC quote. Answer specific questions by going to our Knowledgebase page.  Visit our blogs page for in-depth articles on a variety of topics including how QLACs help with sequence Sequence Risk, how QLACs are similar to and different from Social Securitybest practices in buying a QLAC as well as many other topics. Free Consultation.  If you would like us to develop a free RMD analysis and illustration of how a QLAC might work for you, please click here.





How to Never Run Out of Money In Retirement

ABSTRACT:

The “Failsafe” Strategy is a way to manage a traditional (not Roth) IRA account so that the IRA assets provide income to a retiree for life, no matter how long he or she lives.  The Failsafe Strategy assures the person cannot outlive their IRA savings.

This retirement planning approach employs a new type of life annuity called a Qualified Longevity Annuity Contract or “QLAC.”  If an annuity meets the IRS definition of a QLAC, IRA distributions taken to pay the QLAC premium are not taxable to the recipient.  The QLAC annuity start date can be deferred to age 85 of the beneficiary.

To implement the Failsafe Strategy, an IRA owner purchases a QLAC, then divides retirement into two planning phases:

  • Phase I - From the start of retirement to the date before when the QLAC annuity payments begin (e.g., from 70th birthdate up to 85th birthday).  During this period, the IRA owner withdraws funds from their IRA in approximately equal monthly installments until the IRA balance is nearly dissipated.
  • Phase II - Beginning at the QLAC annuity start date to date of death (e.g., 85th birthday until the age at passing).  During this Phase, the QLAC takes over providing retiree income. The IRA owner receives monthly QLAC annuity payments until they die.

For many IRA owners, the maximum allowable QLAC premium (the lesser of 25% of IRA assets or $125,000) can buy a QLAC lifetime annuity with a benefit greater than or equal to the Phase I IRA payments. Thus, with proper planning, benefits received during Retirement Phases I and II can, when combined, create a level, secure, lifetime stream of income, one that the benefit recipient cannot outlive.  To see how the strategy outlined above might work for you, try the QLACGuru FailsafeSM Maximize Income Calculator Page.  If you prefer a pencil and paper approach, click to see Maximize Income Infographic on how to estimate  FailsafeSM income.

ARTICLE TEXT:

This article describes a strategy that assures that a retiree will never run out of money during his or her retirement, no matter how long retirement lasts. The strategy will be outlined by following a prospective retiree, Ian.  

Ian’s retirement savings are in an Individual Retirement Account (“IRA”)[1]. Ian’s IRA includes funds that his employer contributed when it converted its pension plan from a defined benefit to a defined contribution plan.  Of course, Ian will collect social security benefits, and they are the foundation of his retirement income.  Unfortunately, Ian’s annual social security payments of $30,000 fall short of meeting his estimated cost of living of $50,000 to $60,000 per annum. 

Ian has been a hard worker all his life but never could save a large sum of money. He attempted to be an investor by buying and selling homes in addition to his day job. That effort turned into a major loss in 2008. His wife is deceased, and he has two grown children – one in the Armed Forces and the other a teacher.  Ian also has one grandchild. He owns his home, which is subject to a modest mortgage. He is 69 and plans to retire next year.  Ian has deferred his social security benefits until in the coming year.  His IRA account balance is $500,000.

Four Percent Rule In Current Environment

Fortunately, Ian is on good terms with his brother-in-law, Fred, a CPA.  Fred agreed to sit down with Ian and see how to make his IRA last a lifetime.  First, Fred relayed that there is an old rule of thumb that says that it is safe to withdraw 4% per year from your IRA and not run out retirement money.  For Ian 4% equals $20,000.  Adding the $20,000 to the $30,000 of social security benefits, Ian has $50,000 of spending money - the low end of his estimated retirement needs.  Unfortunately, Fred added that the old rule of thumb was conceived in an era when interest rates were much higher than today.  The conventional wisdom is that retirees should weight their investments towards bonds and other interest income investments to avoid the volatility of equities. Today, prudent planning suggests assuming a 2% rate of return in the IRA during retirement.  With that rate return, Ian’s IRA will be reduced to zero shortly after he reaches age 100.  Ian asked what would happen if the annual IRA withdrawal was $30,000.  For example, inflation could occur, and Medicare is likely to become more expensive; besides, he wants the extra $10,000 each year. 

If the annual IRA withdrawal increases to $30,000, Fred said, the IRA balance would go to zero by age 89.  When Ian seemed relieved, Fred pointed out that current mortality projections show Ian with a 50% probability of living to age 89 or older.  That means there is a reasonable chance Ian will outlive his IRA savings if he withdraws $30,000 annually.   Fred’s advice at this point was for Ian to look at his expenses and determine where he can cut back. It would not be prudent to take more than $20,000 a year out of his IRA during Ian’s retirement unless or until the IRA earnings exceed the projections.

Fred's 'Failsafe' Idea

The following week, Fred called Ian to say that he had an idea.  In his professional reading, Fred had run across a new insurance product, a Qualified Longevity Annuity Contract or “QLAC” for short. Further, there are more than a dozen life insurance carriers offering QLAC annuities. When an annuity contract qualifies under the IRS rules as a QLAC, an IRA withdrawal is tax exempt if used to pay a QLAC premium. QLAC annuity payouts can be deferred as late as age 85 and once begun, must be paid for the life of the beneficiary.  The QLAC distributions are fully taxed to the beneficiary but only when paid. The premium amount is limited to the lesser of $125,000 or 25% of the IRA balance.  Multiplying 25% times Ian’s IRA balance of $500,000 is $125,000, the maximum contribution limit.   (The $ 125,000-lifetime limitation was increased to $130,000 on January 1, 2018, and will increase from time to time after that.) If Ian were to buy a QLAC and defer the payment start date until his age 85, the annual QLAC benefit from a leading insurance agency quoted online would be $33,333 for the rest of Ian’s life. 

Running the Numbers

Once Ian turns 85, the $33,333 annuity is greater than his projected $30,000 income needed to top off his Social Security income. Accordingly, the question is what kind of distribution can the IRA support before age 85?  In other words, with longevity risk eliminated after age 84 by the QLAC insurance contract, Ian can focus on the remaining IRA assets[2] of $375,000.  These assets do not have to support an uncertain lifetime of income, but instead, provide retirement income for a time certain of 15 years - from age 70 through 84.  If the post QLAC IRA balance (i.e., $375,000) earns no income, $25,000[3] can be paid annually until age 85.  A 2% earnings rate in the IRA would justify a $30,000 annual distribution in each of the 15 years.  Ian has met retirement income targets and is assured of an income for life in addition to his Social Security benefits.

Ian asked, Fred, what is the catch?  Why not adopt this “Failsafe” strategy?  Remember that the annuity is a lifetime payout, Fred replied.  After you die, the QLAC payments stop. Most likely, there will be nothing left over for your children.   It is possible to buy a QLAC that guarantees a return of the premium (e.g., Ian’s $125,000 premium) even if you die before scheduled distributions.  Of course, such an annuity pays a lower benefit than a QLAC without a guaranteed return of premium.   In the event of premature death, it might be tempting to label a QLAC as a poor investment.  When a person thinks about a QLAC as an insurance contract that prevents you from running out of money in your old age, it makes a lot more sense.  A QLAC is more like a social security benefit than it is like buying a 20-year bond. 

Learning About QLACs - Who Should Buy, Who Should Avoid?

Next, Ian wondered – why have I not heard of this before? Shouldn’t everyone buy a QLAC? To begin, Fred said, QLACs were created by a Treasury Regulation promulgated in 2014.  It is a new financial product with special tax benefits. People are just beginning to learn about QLACs.  Also, not everyone is a good candidate. First, those folks without an IRA or similar savings accounts are simply out of luck.  The QLAC premium amounts must come out of an IRA or a similar tax-qualified savings account1.  Secondly, individuals with serious health concerns are unlikely candidates for a QLAC.  Presumably, persons in poor health or with a limited expected life span will choose not to participate even though carriers will happily take their premium dollars.  Finally, QLACs are not necessary for individuals who have ample savings and have no concern about running out assets.  Their incomes equal or exceed their spending needs. Most often, these individuals will be planning how their assets are to be distributed upon their passing. On the other hand, QLAC buyers are concerned about their financial resources disappearing in their old age and becoming a burden on their children.  

Ian asked Fred about the IRA required minimum distribution rules and how they might affect the Failsafe strategy.  Ian had heard that once a person reaches age 70½, there must be a minimum distribution from the IRA or severe penalties are imposed by the Internal Revenue Service (“IRS”). The IRS rules divide the life expectancy of a person into the prior year’s IRA balance.  The product is the Required Minimum Distribution (“RMD”).     Because Ian is making the IRA distributions over 15 years instead of a lifetime, each of Ian’s withdrawals will exceed the RMD for each year through age 84.   The QLAC payments occur outside the IRA, so they do not affect the RMD test. Of course, if Ian’s IRA outperforms the 2% assumption, there will be a balance in the IRA at age 85, and that balance will be subject to the RMD test.  It is important to note, however, that there is no IRS penalty for withdrawing more than the RMD or even the entire IRA balance.  

Shop Around to Buy Best Benefit and Ratings

Fred told Ian there are multiple planning opportunities Ian should evaluate before he decides to purchase a QLAC.  This is because a QLAC purchase cannot be undone once contract elections are made and the premium is paid[4].  For example, his QLAC annuity could be decreased by reducing the premium and leaving more money in the IRA.  While most carriers have a minimum premium of $25,000 or more, in Ian’s case he could reduce the premium to $112,500 to create an annuity of $30,000.  Similarly, Ian could elect for payments to start at age 83 or 84 and keep the maximum premium of $125,000.  Since Ian voiced an earlier concern about inflation, he should obtain quotes from those carriers that offer an election to include inflation factors in their QLAC distributions.  Since Ian would depend on long term payout from an insurance company, Fred added, Ian should pay careful attention to the carriers' ratings -- even though state regulators are dedicated to assuring carrier promises are kept to policy beneficiaries.

Before concluding their meeting, Fred told Ian that he wanted to share a recent conversation.  While at his country club, Fred was discussing the merits of the QLAC product with a stockbroker friend.  Fred’s buddy claimed that a QLAC was not necessary – he could create a “synthetic” QLAC by making the right investment choices.  For a minute that seemed possible – but then I asked, what if the choices do not work out?  Will you or your firm guarantee payments for life?  Not surprisingly, my stockbroker friend had no answer.

With that, Fred said, goodnight and happy retirement.  

To see how the strategy outlined above might work for you, try the QLACGuru FailsafeSM Maximize Income Calculator Page.  For more information about QLACs, including Frequently Asked Questions, Articles, and Links to authoritative information about Longevity Annuities, or links to providers Annuity Quotes, please call (800) 460-4166 or visit QLACguru.com



[1] To the extent Ian had one or more IRA, 401(k), 403(b) or 457(b) type of saving plans; he previously consolidated all of these accounts into a single traditional IRA.  Ian did not have nor has a Roth type of savings account.

[2] Original IRA balance of $500,000 – QLAC premium of $125,000 = After QLAC IRA balance of $375,000.

[3] After QLAC IRA balance of $375,000 ÷ number of payment years of 15 = available annual distributions of $25,000.

[4] There are limited options to change the start date of the QLAC payments after a purchase.


So, you’ve decided you need a Qualified Longevity Annuity Contract (QLAC), pronounced cue-lack.  

You have decided that a QLAC purchase is an excellent way to insure against the risk of outliving your assets.  You have sufficient IRA retirement assets for the purchase to make sense.  Your good health makes it reasonable to expect you will need QLAC annuity income when you are in your late 70’s and 80’s and hopefully, after.  You’ve used QLACguru’s calculators, spoken with your advisors, and evaluated whether the purchase makes good sense from a tax perspective.  (Please see our previous blog post on 8 Signs You Need a QLAC).

Now what? 

Set out below is the step-by-step process for purchasing a QLAC.  (For an infographic summarizing this blog piece, click here.) While this process may vary slightly from carrier to carrier and agent to agent, here is guidance on what to expect along the way to owning a QLAC Annuity:[i]

1.       Select an Agent or Broker.  Given the newness of the QLAC product, there are relatively few agents who are well-versed in the sales and illustration of QLACs.  Whether you ultimately buy from an online agency or a local provider, we recommend starting with an online agency with a comparison quoting engine.  Why?  Annuity Carriers vary in terms of how they price different QLAC product features. Local agents typically represent only one or two carriers while online agents like immediateannuities.com will quote 7 or 8.  So, even if you are uncomfortable making your purchase online, it pays to start your QLAC journey comparison shopping multiple carriers online first, rather than go straight to a single, local provider.  

 Here are five questions we ask when selecting an agency:[ii]

  • How long has the agency been in business?
  • With how many carriers offering QLAC annuities does the agency work?
  • How many QLAC annuities has the agency sold?
  • What is the agency’s Better Business Bureau Rating?
 

2.       Select QLAC product attributes that are best for you.  If you are married, you will need to determine whether you want to have income over the length of one life or choose a Joint & Survivor benefit which will pay over the lives of both you and your spouse.  If you have children or other heirs in your retirement plans, you will want to choose between an annuity with a “Cash Refund” (Return of Premium -- ROP) feature which provides a return of the unpaid premium amounts upon your death and a “Life-only” annuity with no death benefit.  A Cash Refund/ROP annuity will provide a better outcome for your heirs if you die early but will pay a lesser benefit during your life than a Life-only policy.

3.       Select a carrier.  Each of the decisions about product features above includes economic trade offs.   Each of these features will be priced differently by different carriers.   Also, you will want to verify the claims-paying abilities of each of the carriers by checking their credit ratings (e.g., A.M. Best).

4.       Request Annuity Purchase Paperwork.  Know what you want? Ready to pull the trigger?    It is time to contact your agent or broker.  Together, you will review your plans.  Your agent will go through an application questionnaire with you, which will allow your agent to complete the carrier’s annuity application partially.  During the review of the application questionnaire, the agent will verify the amount of the annuity purchase, making sure you are meeting all the tax rules for a QLAC purchase, including limits on how much you can contribute to your QLAC annuity.   The Qualified Longevity Annuity Contract or "QLAC" premium purchase is limited to 25% of a retirement plan (i.e., assets held in tax-qualified accounts such as an IRA), but no more than $130,000 from all plans.  Your agent will request a copy of your end-of-prior-year IRA balances from your IRA account required for the paperwork.   Other questions in the questionnaire will include the name of your IRA Custodian and your IRA account number.  Your QLAC application will also include a funds transfer form, which allows your insurance carrier to request funds directly from your IRA custodian. This kind of transfer is called a trustee-to-trustee transfer, which means you will not need to write a check to buy your QLAC policy.     

5.       Complete and Mail Annuity Application Paperwork.  The agent will overnight the carrier application to you for your review and signature.  The agent will typically include a prepaid envelope which you will use, depending on the carrier, to mail the application and funds transfer form to the carrier for processing.  It is important to review your annuity application paperwork with your agent and sign all the forms including the funds transfer form. Once the application is completed, your work is done.  The agent or broker will follow up with the insurance company to make sure that the package was received and is in good order. 

6.       Sign Receipt of Policy Delivery Notification.  Over the next two weeks, the Insurance company requests funds using the form you signed, and the IRA custodian mails the check to the Insurance Company on your behalf to purchase the annuity.  Then your QLAC annuity contract is printed by the carrier and overnighted to your agent. Your agent will make sure that the contract is correct, and will then overnight the contract to you.  Once you receive the contract, you will be asked to sign and return a receipt of delivery notification.  This notification is to confirm that you have received the annuity contract.  Often, both the carrier and agent (or broker) will request a copy of this document.

7.       Calculate Your Lower Required Minimum Distributions!  Once the carrier funds your QLAC, it must file a 1098-Q identifying you as the owner of a QLAC.  The document includes your taxpayer ID and the balance of the newly formed QLAC.  After age 70 and ½, your Required Minimum Distributions will be reduced because the QLAC purchase price is no longer part of the IRA account balance. Because the distribution was made to purchase a Qualified QLAC, that IRA distribution is not as taxable. 

8.       Receive Yearly Annuity Account Correspondence.  You will receive an annual statement of account from the insurance company.   This statement typically includes the Income start date and the amount of the benefit.  Depending on your annuity contract features, some companies will allow you to adjust the annuity start date, moving it backward or forwards in time, typically in five-year increments.  This flexibility usually applies to cash refund (Return of Premium) policies only.  (If you think you’ll want this kind of flexibility, ask which carriers offer this flexibility before you buy the QLAC.)

9.       Decide How Annuity Payments Should Be Made.  One to two months before the income start date of your annuity, many carriers will send a letter offering to set up direct deposit.  You can choose to receive a paper check or direct deposit.  For this, you will need to provide a voided check and your checking account information.

10.   Enjoy Life-long Annuity Benefits Payments.  Congratulations!  Because of your careful planning, you will receive annuity payments from the insurance company for the rest of your life.  Uncle Sam will treat your QLAC annuity benefit payments as ordinary income.  You will receive a 1099-R from the insurance company at the end of each year recognizing this income to you.  The longer you live, the smarter you will feel about your QLAC purchase! 



Want to learn more? Check out our videos page to see additional QLACguru videos.  See our calculators page to develop an anonymous RMD calculation and estimated QLAC quote. Answer specific questions by going to our Knowledgebase page.  Visit our blogs page for in-depth articles on a variety of topics including how QLACs help with sequence Sequence Risk, how QLACs are similar to and different from Social Security, as well as many other topics. Free Consultation.  If you would like us to develop a free RMD analysis and illustration of how a QLAC might work for you, please click here.


8 Signs You May Need A QLAC

A Qualified Longevity Annuity Contract (QLAC)  – pronounced 'cue-lack' - is a new type of annuity product designed to insure against the risk of outliving retirement assets.  The QLAC investment was made possible by enabling legislation from the US Treasury in July 2014.  At that time, the Treasury issued final IRS regulations that defined QLACs.  The QLAC  product remains relatively unknown to the investing public. 

Briefly, an owner of a traditional Individual Retirement Account[1] (“IRA”) can transfer funds out of the IRA to pay a premium[2] to purchase a QLAC.  That transfer is not treated as a taxable event.  Instead, the asset balance in the IRA is reduced by the transfer/premium, thereby reducing required minimum distributions from the IRA.  (Go to qlacguru.com/calc to find a free tool to help project tax deferral amounts).  Only distributions from the QLAC are taxed to the owner, and such distributions can be deferred to as late as age 85.  Once distributions begin, they are paid for the life of the QLAC annuity owner[3], no matter how long he or she might live. (Click here to open a separate window on a partner site to see how much monthly income a QLAC purchase might generate.)

QLAC’s are not for everyone. Here are eight signs that you, an IRA owner, may be a candidate for a QLAC purchase. (For an infographic summarizing this blog piece, click here.)

1.       I am retiring or about to turn 70 and ½.  Age has an important bearing on when to make a QLAC purchase.  QLAC investors typically choose to make a QLAC purchase near retirement (for example, the early to late sixties), or upon reaching the age of 70 ½.  Here is why.

·         At Retirement.  At retirement, many retirees choose to or are required to move their assets from their employer-sponsored retirement accounts (e.g., IRA, 401(k) or 403(b) accounts) into an individually managed IRA account. At that time, retirees are faced with their first decision whether to purchase a QLAC.

·         At Age 70 ½.  The next most common time to evaluate QLACs is when an IRA owner approaches age 70 ½. This milestone is the age at which IRS accounts[4] will be required to begin taking  Required Minimum Distributions (“RMDs”), or the owner will subject to severe IRS penalties. For those outside the top 5% in income, the question becomes one of measuring the income security from a bond portfolio versus the guaranteed income from a QLAC.  Also, to be factored in is the tax cost of RMDs without a QLAC versus the savings from reduced RMDs with a QLAC. Go to  qlacguru.com/calc to find calculators that will help analyze how much one may contribute to a QLAC and the tax deferral impact of a QLAC purchase.

2.       I am healthy and expect to live for a long time.  Good health and likely longevity are key variables in deciding whether to purchase a QLAC.  For example, take a 69-year-old male smoker with a history of cancer and heart disease in his family.  This man is highly unlikely to see his 80th birthday. A QLAC is probably not for him. This is because the QLAC has no cash value and cannot be undone after purchase.[5] On the other hand, for a 69-year-old-female in great health and with a family history of great longevity, a QLAC purchase can make a good deal of sense.  QLAC annuities payments will continue for life, even if she lives to be 105!

3.       I have retirement assets.     Most insurance carriers offering QLACs have $15,000 minimum premium.  Immediateannuities.com prefers to sell QLACs with a minimum purchase amount of $20,000.  This translates to a minimum IRA balance of $60,000-$80,000. The overall premium limit of $125,000 is 25% of $500,000 of IRA assets. The Qualified Longevity Annuity Contract or "QLAC" premium purchase is limited to 25% of a retirement plan (i.e., assets held in tax-qualified accounts such as an IRA), but no more than $130,000 from all plans.  (The $125,000 lifetime limitation was increased to $130,000 on January 1, 2018 and will increase from time to time thereafter.)  As the QLAC premium falls as a percentage of a persons’ IRA assets (over overall assets), the relative impact will decline.  But if two members of a couple each own separate IRAs, both members may purchase a QLAC, subject to the previously mentioned limits.

4.       I have an estate plan in place.  Most parents want to avoid becoming dependents of their offspring.  A QLAC is designed to do just that – lifetime income prevents one from becoming a dependent. On the other hand, a QLAC is not a tool to build an estate.  Typically, the QLAC purchaser’s gift to the next generation is freedom from the need to financially support and physically care for the prior generation.    Go to the Get Quote tab on the right-hand side of the page on QLACguru.com to see how much income a QLAC purchase would provide.

5.       I can use some help staying on budget.  By the time we reach our sixties, some of us are very good at living on a budget.  Others are not.   A person with too little discipline can easy spend away savings with a weakness for travel, new cars, expensive clothes, or lavish gifts for grandchildren.  For this individual,  a QLAC purchase can impose discipline by simply making the assets out of reach.   Socking away up to 25% of your retirement assets now into an instrument that will begin paying fixed amounts during later years, can be a clever way of budgeting for future retirement income needs.  Ironically, this can allow one to be less concerned about the adequacy of savings early retirement years, safe in knowing that the income needs anticipated in later years have been addressed by the QLAC purchase.

6.       The Investment climate is uncertain.  The current stock market, bond market, and interest rate returns can have an important bearing on the decision to purchase a QLAC. If returns to investors are high, as they were during the 1990s, for example, then an IRA owner may be able to apply the 4% rule of thumb, selling off 4% of the IRA assets each year and applying the proceeds to living costs. If, on the other hand, the investment returns climate is more uncertain (as it has been in recent years), then that IRA owner may want to purchase a QLAC and lock in an annuity payment for the future. The QLAC will deliver a fixed return and remainder of assets in the IRA will still subject to market gains or losses.  The QLAC buyer has simply reduced his or her exposure to market fluctuations.

7.       I have a lower tolerance for risk.   Some people lay awake at night and worry when there is turbulence in the markets. For these folks, a QLAC may be a good way to assure future income and current rest. If, on the other hand,  someone is comfortable with fluctuations in the market, even those that affect a retirement nest egg, then that person may be more comfortable self-insuring against the probability of running out of money in retirement.

8.       I want to defer taxes.  A QLAC offers two potential tax advantages, which may or may not be of consequence to different IRA owners.  When the IRA withdrawal occurs to pay a QLAC premium, that distribution is not taxed.[6]  QLAC distributions are fully taxable when paid.  As a result, the QLAC buyer gets a 10 to 20-year deferral of taxation between premium payment and benefit receipt.  Further, in most instances, the IRA owner is in a higher tax bracket at the premium purchase date than he or she will be when the QLAC pays benefits.  Both tax deferral and lower tax rates can mean more spending money for the OLAC buyer. The second QLAC tax benefit is that the QLAC premium is not deemed part of IRA assets – even though there was no distribution deduction treatment.  The RMD is determined by dividing the IRA assets (after the QLAC premium withdrawal) by a fixed factor that IRS sets for each age.   With the IRA assets reduced by as much as 25%, the RMD after a QLAC purchase reduces proportionately. When this reduced RMD is sufficient to meet living expenses, the IRA plus the QLAC should produce enhanced future retirement income over the IRA alone alternative.  Every person’s facts and needs are different. (Click here to open a calculator that can show how this might work based on your facts.) There will be exceptions to any generalization. 

Want to learn more? Check out our videos page to see additional QLACguru videos.  See our calculators page to develop an anonymous RMD calculation and estimated QLAC quote. Answer specific questions by going to our Knowledgebase page.  Visit our blogs page for in-depth articles on a variety of topics including how QLACs help with sequence Sequence Risk, how QLACs are similar to and different from Social Securitybest practices in buying a QLAC as well as many other topics. Free Consultation.  If you would like us to develop a free RMD analysis and illustration of how a QLAC might work for you, please click here.


[1] QLACs can be purchased using funds from other tax-qualified savings vehicles such as IRC Section 401(k), 403(b) and 457(b) accounts.  No “Roth” accounts are eligible for QLAC purchases.   Herein, when we use the term “IRA”, it is implied that the same conditions and terms apply to the other accounts.

[2] The maximum premiums are a function of the IRA (or IRAs) asset balances.  Collectively, the limit is 25% of IRA assets or if less, $125,000. 

[3] Married couples can be designed as joint beneficiaries at the policy owner’s election.

[4] IRC Section 401(k) accounts have some unique exceptions which can allow distributions to be deferred past age 70 ½.

[5] At inception, a buyer can elect a QLAC policy form that returns a minimum of the premium invested to the policy owners’ estate.  That amount is reduced by any benefit distributions received by the QLAC owner.

[6] IRA distributions are treated as fully taxable.  This treatment is the flip side of the IRS permitting contributions to IRAs being tax deductible. Very rarely, there can have been non-deductible contributions to an IRA.  Distributions relative to these contributions require special treatment.



Ida May Fuller was the first Social Security beneficiary.  Ms. Fuller paid $22.54 of social security taxes before her retirement in 1940.  Dying in 1975, Ms. Fuller enjoyed Social Security benefits totaling $22,888.92 collected over 35 years.  If Ms. Fuller had passed away before retiring, her total benefits would have been zero.  Social Security is a government-sponsored retirement income assurance program paid via a tax on wages and other earned income.  The tax is akin to an insurance premium with benefits that terminate at death.

A Qualified Longevity Annuity Contract (“QLAC”) is a new type of deferred annuity contract defined by IRS regulations issued in 2014.  A QLAC policy is issued by an insurance company and is not part of the social security system. Still, both programs share the common attribute that beneficiaries collect benefits for life.  Both Social Security and QLAC policies are a form of insurance – providing an income benefit for the life of the participant. Both share the fundamental attribute of assuring that the participant receives a defined cash flow during his or her lifetime. QLACs and Social Security share other similarities and have essential differences.  The table below contrasts the attributes of the two plans and will help explain QLACs by the comparison. 

The above chart does not touch upon many details of both the Social Security program and QLAC annuity contracts.  Still, it does capture the essential features of the two plans.  Despite the differences noted above, a QLAC contract has a distinct resemblance to the Social Security benefit plan.  The QLAC benefits are designed to assure benefit payments in later life when IRA (or other qualified account savings) may be depleted.  The most common shared attribute is that both provide a lifetime of set cash flows during a beneficiary’s retirement – no matter how long he or she lives.  The long term adequacy of IRA (or other qualified savings) accounts is assured by a QLAC purchase because it pays benefits for however long the beneficiary survives.  Social Security income is simply a floor to prevent retirees from living in relative poverty.

A QLAC is a new and vital retirement planning tool.  There is no benefit for a person without tax-qualified savings.

Further, those persons with significant qualified and other savings (say, more than a $1 million) have less risk of running out of money during an extended life span.  In between - where qualified savings range from $100,000 to $1,000,000 – the prospect of a long life presents a real risk of running out of savings and, as a result, reduced quality of life.  For these retirees, a QLAC can assure a stream of retirement cash flow that supplements their Social Security benefits – no matter how long they live. 

Want to learn more? Check out our videos page to see additional QLACguru videos.  See our calculators page to develop an anonymous RMD calculation and estimated QLAC quote. Answer specific questions by going to our Knowledgebase page.  Visit our blogs page for in-depth articles on a variety of topics including how QLACs help with sequence Sequence Risk, how QLACs are similar to and different from Social Securitybest practices in buying a QLAC as well as many other topics. Free Consultation.  If you would like us to develop a free RMD analysis and illustration of how a QLAC might work for you, please click here.


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