Longevity annuities are one of the newest financial planning tools for retirees who have a good chance to live a very long life. While they have been around longer, they’ve had a steep uptick in attention over the past year. A lot of this attention has come from the government’s support of these longevity annuities, also referred to as deferred income annuities. The U.S. Treasury Department recently classified them as Qualified Longevity Annuity Contracts and specified their rules for how these QLAC’s can be used to create income from defined contribution plans like 401k’s and IRA’s. These products typically start paying you income late in life, often age 80 or 85. While there are many people who would not benefit from a longevity annuity, particularly those in poor health who aren’t expected to live as long, a lot of Americans could benefit from this additional income later in life. It helps protect against the risk of outliving your savings in your 80’s and beyond. In the CBS Moneywatch article, “A new tool for retirees who expect to live long,” Steve Vernon talked about the results of a recent study done about the use of QLAC products in retirement planning.
The study was performed by the Stanford Center on Longevity (SCL) and the Society of Actuaries (SOA). It looked at the best ways to use QLAC’s in your portfolio. A common strategy is to put around 15% of your retirement savings into a longevity annuity that will start paying you income once you turn 85. You will continue to receive these income payments for as long as you live. You could use a systematic withdrawal plan to finance your retirement up until that point because you know the ending date that you won’t need to use that savings anymore. Some people use term-certain immediate annuity products to finance the earlier portion of their retirement. There were 36 different strategies compared in the study that used different QLAC and systematic withdrawal plan calculations. They compared this strategy to using only systematic withdrawals, only annuities, or a combination of systematic withdrawals and traditional annuity products. The QLAC and systematic withdrawal plan was able to provide a higher level of lifetime retirement income, but with one main concern. There is a decline in the income between the ages of 84 and 85, no matter what happens in the markets during that time.
Even with this decline though, the QLAC and systematic withdrawal plan is valuable to many people, especially if you account for the decline in income at age 84 in advance. There are a few important decisions required when using this combination plan. First, figure out how much money you want to use to purchase your QLAC. Then work with a financial advisor to come up with a systematic withdrawal plan and asset allocation that helps minimize the income decline that occurs between the ages of 84 and 85. Finally, you have to decide whether you want to add a death benefit to your QLAC or forego the death benefit for higher retirement income.
This combination strategy isn’t the only way that you can benefit from using QLACs. You can purchase a QLAC that will pay only the minimum amount of income you think you will need in your advanced age. If you don’t modify your assets to account for the income decrease between ages 84 and 85, you can prepare yourself to deal with the known income disruption. Another way to use a QLAC would be to purchase one that starts paying you earlier in life, for instance at age 75. Then you could work or use systematic withdrawals, or both, until that age. Finally, you can layer more income from a QLAC that starts paying later in life and use it to help pay for the increasing medical costs and long term care costs that come as we age. Longevity annuities, especially those used as QLACs, are important retirement income planning tools.
Written by Rachel Summit