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QLACs Hedge Against Longevity Risk

For those nearing or in early retirement, the fear of running out of money is a very real concern. Enter the qualified longevity annuity contract, or QLAC. With this relatively new option, you can invest up to 25% of the total balance of your IRAs and 401(k)s, not to exceed $125,000 with an insurance company. In exchange, the company will pay you an annual income for life starting anytime between when you turn 70 ½ and 85. According to a recent Forbes article, the longer you wait for your payout, the bigger the annual payment.

“It’s just like a personal pension,” says Joe Signorella; a certified financial planner in Chicago who helps clients use longevity annuities, like QLACs to cover financial needs in retirement. “The government wants you to use QLACs; people are pulling the trigger,” he says.

A recent academic study out of the University of Pennsylvania’s Wharton School, showed how using a portion of retirement savings to purchase a lifetime annuity is a cost-effective way to hedge longevity risk. The study, Putting the Pension Back in 401(k) Plans, also demonstrated that these products provide people with substantially higher consumption levels, particularly at older ages.

“This really has a very strong benefit for a variety of people,” co-author Olivia Mitchell, an insurance professor at the university explained. “These things are really cheap and you get great protection,” she added.

While you can purchase a deferred fixed annuity similar to QLACs with money other than retirement funds, there are advantages to using IRA dollars. The amount you invest in the QLAC isn’t counted in your IRA balance when you reach age 70 ½ and must start taking required minimum distributions from your account. Once you start taking payments though, they’ll all be taxed at regular income rates.

At this time, only about 3% of large employers’ 401(k)s offer QLACs. If you’re interested in one, you’ll likely have to rollover your 401(k) into an IRA first. As with any major financial decision, when looking to purchase a QLAC, it’s recommended to take the time to research and shop around for several quotes to be sure you’re getting the best deal possible. And before signing on the dotted line, it’s wise to discuss the purchase with a trusted financial advisor to be certain this unique annuity product is a good fit for you.

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