The Employee Benefit Research Institute is a non-profit research group dealing with retirement readiness in America. Recently, they looked into whether QLACs will actually increase the retirement readiness of 401k participants and found that they most likely will. This information comes from Nick Thornton’s Benefits Pro article, “EBRI modeling shows QLACs boost retirement readiness.”(1) The U.S Treasury Department changed regulations last year, allowing those with qualified retirement plans to use 25% of their retirement savings to purchase a Qualified Longevity Annuity Contract. The maximum amount of money that you can use is $125,000. This money can be deferred in the longevity annuity until age 80 or 85, so that it is not included in the required minimum distribution rules that begin at age 70 1/2.
The research found that 401k plan participants who use a QLAC in their retirement plan have the potential to significantly increase their retirement readiness. That potential will actually increase even more when interest rates rise as well. Longevity annuities cost less for retirement savers when interest rates are higher. One of the main factors that the EBRI uses to determine retirement readiness is how people have accounted for longevity risk. QLAC’s are a newer, useful way to account for longevity risk in retirement income planning.
The EBRI uses their own proprietary Retirement Security Projection Model to gauge retirement readiness. Many people in the financial industry believe this to be the most comprehensive system available. They studied two different ways to use QLAC’s in a 401k plan and put them against the retirement readiness model. The first option ladders QLAC purchases over 10 years using 15% of the person’s retirement plan assets. This scenario hedges against interest rate fluctuations, especially if rates were to increase dramatically over the next 10 years. Both Generation X members and younger Baby Boomers showed a notable increase in retirement readiness ratings using this scenario. The second option studied was to use the accumulated employer match contributions in a 401k plan to purchase a QLAC upon retirement. The two groups studied also had increasing retirement readiness ratings when the employer matches were used to buy a QLAC at retirement.
Those who live the longest will benefit the most from QLAC purchases. But the EBRI retirement readiness model found that overall retirement readiness was still higher, even after accounting for those who died younger. The transfer of longevity risk to an insurer helps increase overall retirement readiness even though interest rates are still historically low. MetLife was the first insurance company to introduce a QLAC made specifically for 401k plans in May. Since then, more insurers have jumped on board. This is all still new for the industry though, so more insurers are likely to introduce products as legalities are ironed out and fiduciary responsibilities are further clarified.
Written by Rachel Summit
1. Thornton, Nick. “EBRI modeling shows QLACs boost retirement readiness.” Benefits Pro. August 27, 2015. https://www.benefitspro.com/2015/08/27/ebri-modeling-shows-qlacs-boost-retirement-readine