Understanding Qualified Longevity Annuity Contracts (QLACs)
We have received a number of inquiries from clients recently about Qualified Longevity Annuity Contracts (QLACs). As with most types of “financial solutions,” the attractiveness of QLACs is in the eye of the beholder. Let’s take a look under the hood!
First of all, the purpose of a QLAC is to protect investors against the risk of an extended life expectancy or longevity. Here are the basics of how this type of annuity works:
Investors make a lump sum payment, up to a maximum of $200,000, from their IRA, or 401k plan into a QLAC. In return, the insurance company promises to pay the investor a predetermined stream of income at some point in the future. The commencement day of the income payout is specified by the investor in the beginning when they make their original contribution to the annuity.
The size of the income stream from the annuity is dependent on your age upon starting the income stream. The longer you defer payments from the annuity, the higher the periodic payments will be because of your shorter life expectancy. The income payments from the annuity must commence at, or prior to, the age of 85.
Once the payments from the QLAC begin, they continue for the duration of your lifetime.
What are the advantages to this type of financial product?
There are several notable advantages to QLACs as follows:
The insurance company promises to pay you a known and quoted upfront income benefit for the duration of your lifetime.
The income stream promised when funds are deposited into a QLAC does not fluctuate due to stock market returns.
The funds that are removed from your IRA or 401k plan in order to purchase a QLAC reduce the size of your calculated required minimum distribution (RMD). Because your RMD is lower, the tax liability associated with the RMD is lower.
What are the drawbacks of this type of annuity?
As with any financial product, there are a number of drawbacks to consider including:
Those who purchase a QLAC are essentially removing money from their IRA or 401k in order to buy a future income stream. It is generally not possible to access these funds at all prior to the date income payments start. In addition, there is an opportunity cost of the possible investment earnings lost as a result of removing invested funds from your portfolio.
Once the income payout commences, it cannot be adjusted. The income stream is a fixed amount.
While the income payments for life sound attractive, there is a significant “pay back” period with this type of investment. In other words, how long do you have to live in order to receive your original contribution to the QLAC back?
This income stream is a promise from the insurance company, but the solvency of the insurance company is not guaranteed.
Beacon’s Take
We recognize that the benefits QLACs can offer is an option to mitigate longevity risk, however, we are not huge fans of this type of annuity product. In our experience, people’s circumstances can change significantly over time and QLACs serve to restrict flexibility, which we believe is especially important as people age.
While the guaranteed feature of QLACs can be appealing to some, the limitations and drawbacks should also be considered in the context of your personal financial plan. If you have any questions, please feel free to contact our office.