While attending a physics symposium in Las Vegas, Albert Einstein, to the astonishment of many of his sober-minded colleagues, spent a fair amount of time at the craps and roulette tables.
“Einstein is gambling as if there were no tomorrow,” an eminent physicist remarked one day. “What troubles me,” another replied, “is that he may know something!”
On February 3, 2012, the IRS released proposed regulations to establish “qualified longevity annuity contracts” (QLACs) in retirement accounts. In normal people’s words, these are annuities that can be purchased with assets held in IRAs and 401(k)s. The government must know something!
The government knows that, according to a report in USA Today, 55% of workers are willing to give up some of their future pay increases to have more guaranteed income in retirement. The government also knows that the EBRI Center for Research on Retirement Income released data in 2011 that shows workers are more pessimistic about having enough money for retirement than at any other time in the past two decades.
The QLAC is a potential response to those concerns. It would allow workers to take a portion of their retirement accounts and convert it to a monthly payment for their lifetimes (similar to income from Social Security and traditional pensions).
Nuts and Bolts
The basic guidelines for the QLAC are:
- Workers will be allowed to purchase a QLAC up to the lesser of $100,000 or 25% of their retirement account balance. A husband and wife can each purchase a QLAC up to $100,000 from their own retirement accounts.
- Distributions from QLACs begin the first day of the month following the owner’s 85th birthday.
- The only death benefit offered is a lifetime annuity to a designated beneficiary.
What are the advantages?
- Lifetime income. Workers find comfort in having an income they cannot outlive.
- Reduced required minimum distributions (RMDs). The portion of your retirement account set aside in a QLAC would not count toward your RMD calculation. This would reduce the amount you are required to withdraw from a retirement account. Therefore, it would reduce your taxable income for those who do not need their RMD.
What are the disadvantages?
- Age. QLACs would begin at age 85, perhaps not leaving many years for the average person to benefit from the annuity.
- Cost. The traditional knock against annuities issued by insurance companies is that they are expensive. What will government-mandated QLACs cost?
- Inflation. The QLAC payment amount (like most annuities) is fixed, so purchasing power will be eroded by inflation. Even at the low inflation rate of the last decade (2.48%), a $1,000 annuity would be “worth” only $783 in real dollars 10 years later.
- Diminished financial legacy. Workers are reluctant to invest in annuities because there is “nothing left over” for heirs. Payments stop when the owner or designated beneficiary dies. In contrast, with a retirement account, the balance is passed on to the designated beneficiary (spouse) and to heirs (children) in a lump sum. This lump sum can be stretched across many years to minimize taxes.
What Is the Potential Impact?
Most workers already have a monthly annuity that can begin as early as age 62 and is adjusted for inflation: Social Security. The QLAC would act like a supplement to Social Security, but not until age 85 and without inflation adjustments.
To put it in perspective, the present value of an annual Social Security benefit of $20,000 ($1,667 per month) for 30 years with a 3% annual adjustment is $392,000. In other words, if you have $392,000 in the bank, you can convert it to a $20,000 annual payment for 30 years, with a 3% annual increase (ignoring taxes for the moment). But the maximum you can convert to a QLAC is $100,000, so its income stream will be much smaller than Social Security.
No doubt the QLAC will be challenged in Congress, and who knows what final form it will take. But it’s encouraging that the government is being proactive in addressing baby boomers’ retirement. In the meantime, BWFA will continue to invest your assets in a diversified portfolio to produce the stream of income you are seeking in retirement.