The “Not So New” Lifetime Income Guarantee

By Marc Shaffer

If you aren’t familiar with longevity annuities and Qualified Longevity Annuity Contracts yet, chances are you will start to hear more about them this year…especially if you are over the age of 55. While countless mailings may have you convinced that this is a new product, it has actually been around for a while. However, these annuities are being heavily marketed now that a new law is allowing them to be purchased with retirement funds from an IRA account or a qualified plan such as a 401(k) plan or profit-sharing plan.

Most people do not have access to pension plans from their employer like they may have in the past, so the risk of living longer and running out of money is more of a concern than it used to be. In contrast to a pension plan, people are now saving large sums of money on their own (either in a retirement plan or other vehicle) and must determine themselves, or with the help of their financial advisor, how much their portfolio can support in withdrawals annually without being exhausted prior to their death. This means retirement funds can be subject to overspending, unplanned investment losses and ultimately living longer than anticipated. When you have a pension, this risk is lessened because they were designed to last until your death. Longevity annuities could have the ability to act as the pension that few people have, but many people desire.

What is a Longevity Annuity?

Longevity annuities are insurance products designed to protect you from outliving your money late in life. In exchange for a premium payment up front, the annuity provides for a steady stream of income later in retirement. These policies are usually purchased at a younger age and then begin paying out at an agreed upon date in the future, not to exceed age 85. Many retirees worry that their nest egg will not last their entire lifetime. By purchasing a longevity annuity you guarantee the stream of income for the future, should you reach the beginning age of payout.

What’s the difference between a Longevity Annuity and a Qualified Longevity Annuity Contract (QLAC)?

This is a common question, but the difference is not in what the product is, but in how you purchase the product. Within certain parameters, anyone can purchase a longevity annuity if they have the funds to cover the premium. However, if you want to purchase a longevity annuity inside a tax-deferred IRA or employer-sponsored retirement plan, you previously encountered potential problems due to required minimum distribution (RMD) laws. The laws regulating QLAC now give you the option to make this purchase inside your tax-deferred accounts if all of the QLAC requirements are met. This means it is not included in the value of your tax-deferred account, and therefore is not included when calculating your RMD.

What are some factors I should keep in mind as I weigh the pros and cons of a longevity annuity?

  • By purchasing a longevity annuity, you know when the benefits are expected to begin and how much you will receive each year. Therefore, you reduce the risk of your portfolio running out before death and may need to only plan for your nest egg to support your living expenses until the annuity begins. Keep in mind the lifetime annuity payment may not increase with inflation and may not cover your full expenses so plan accordingly.
  • Policies may be sold on a “use it or lose it” basis. This means if you don’t reach the age of the start date, or if you pass away having only received a few years of the benefits, the remainder of the premium you paid will be lost. However, there are some longevity annuity solutions with “period certain” and “cash refund payout” options or the ability to elect a Return of Premium feature to combat these issues. An election of a payout option that entitles the annuitant to a refund of remaining premium or pre-death return of premium would typically result in a lower payout amount than if these options were not included.
  • If you have a low life expectancy, a family history of potential diseases or health issues, or do not expect longevity for any other reason, this may not be the best source of income for your situation.
  • Longevity annuities may be more attractive if you aren’t worried about creating an inheritance for dependents. If you were to pass away leaving a spouse that relied upon your income to live, it might make sense to have another income source they could use, unless you add a death benefit feature to your annuity.

Longevity Annuities vs. Personal Savings and Assets

For those with ample assets, you may be better served with more traditional investment strategies such as a diversified portfolio to help you create enough income to last your lifetime. Annuities, including longevity annuities, are not about maximizing investment returns, they are about providing guaranteed income. Periodic withdrawals from a diversified portfolio may last for the investors’ lifetime, may generate income that exceeds their living expenses, or may fail to provide enough for the required living expenses for life. The annuity is guaranteed to continue payments for life.

You should consider the opportunity cost of not having the dollars you trade for purchasing the guarantees provided by a longevity annuity premium vs. investing those same dollars in a diversified portfolio with potentially higher returns. Because of that opportunity cost, it is often suggested to limit an investment in longevity annuities to no more than 10 percent to 15 percent of one’s total portfolio. If you do plan to purchase a QLAC with retirement assets, remember that only the lesser of 25 percent of the retirement assets or $125,000 can be used to purchase the longevity annuity.

There may be a place for longevity annuities in your financial plan, but work with your financial advisor to discuss the potential of your options and find out if an annuity would make sense for your situation.

Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this content, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for you or your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter (article) serves as the receipt of, or as a substitute for, personalized investment advice from Searcy Financial Services, Inc.

The content of this letter does not constitute a tax or legal opinion. Always consult with a competent professional service provider for advice on tax or legal matters specific to your situation. To the extent that a reader has any questions regarding the applicability of any specific issue discussed in this content, he/she is encouraged to consult with the professional advisor of his/her choosing.  

Published for the blog on April 6, 2015 by Searcy Financial Services, your Overland Park, Kansas Fee-Only Financial Planner and Investment Manager.