In the years to come, it should be easier to generate lifetime retirement income from your 401(k) plan, thanks to some recently enacted regulations from the Treasury Department. These rules cover qualifying longevity annuity contracts (QLACs), also known as longevity annuities or longevity insurance. Let's learn more about this valuable tool.
A QLAC is a contract with an insurance company that pays a monthly income starting at an advanced age, such as 80 or 85, that's payable for the rest of your life, no matter how long you live. Think of it as insurance against the possibility that you live a long time and as an option if you need a lot of money to last the rest of your life.
Typically, you'd buy a QLAC in the years leading up to retirement or just upon retiring. Obviously, you'll need other sources of retirement income before the money from the QLAC starts, and most likely you'd use invested assets for this purpose.
With 401(k) accounts and deductible IRAs, under the required minimum distribution (RMD) rules, you would normally need to begin withdrawing minimum amounts at age 70-1/2. For example, suppose you're age 70-1/2 with $100,000 in retirement savings. You would need to withdraw at least 3.65 percent of the amount in your account during the year, or $3,650. The new regulations allow the money invested in a QLAC to automatically comply with these rules, even though the income will start well after age 70-1/2.
The amount you're allowed to invest in a QLAC is limited to the lesser of two options: 25 percent of your account balance, or $125,000.
- Example 1: You have $800,000 in your account balance. You can invest $125,000 in a QLAC because 25 percent of $800,000 is $200,000, more than the $125,000 limit.
- Example 2: You have $100,000 in your account balance. You can invest $25,000 in a QLAC because that's 25 percent of $100,000.
The basic purpose of a QLAC is to enable you to invest part of your savings and draw it down to meet your living expenses in retirement without having to worry that you'll outlive your savings. It's expected that most retirees would devote only 10 percent to 20 percent of their retirement savings to a QLAC, with the remainder invested to generate retirement income before the QLAC kicks in. This way, you'll still have access to and flexibility with most of your savings, and any unused invested funds at your death can go to your heirs.
The regulations also allow a QLAC to pay benefits in the event that you die before reaching the age that income starts. That money can become an income to a named beneficiary such as your spouse, or a "return of premium" death benefit that refunds the premiums you paid for the contract upon your death. However, choosing the death benefit option will reduce the amount of retirement income you would receive if you live to the age the income starts.
Where can you buy a QLAC? At the moment, not many 401(k) plans offer them, but this should change as plan sponsors become more aware of the new rules. Online annuity bidding services, such as Income Solutions, now offer QLACs. One way to access this service is through Vanguard's Annuity Access.
Let's look at some examples of the income a QLAC might generate compared to conventional annuities. Suppose you have $100,000 that you can devote to a QLAC. According to quotes earlier this year from Income Solutions:
- A man who is 65 years old today could receive a fixed monthly income of $5,012 starting at age 85. With this quote, no death benefit is payable if he dies before age 85. If this man bought a conventional fixed annuity that started right away at age 65, his monthly income would be about $590.
- A 65-year-old woman with $100,000 to invest in a QLAC could earn a monthly income of about $4,253 starting at age 85. No death benefit is payable if she dies before age 85. If she bought a conventional annuity that started at age 65, her monthly income would be about $563.
- A married couple, both age 65 and with $100,000 to invest in a QLAC could buy a monthly income of about $2,882 starting at age 85, payable as long as one of the couple was alive. No death benefit is payable if both die before age 85. If they bought a conventional annuity that started at age 65, their monthly income would be about $502.
The insurance market for longevity annuities is evolving, and we'll likely see new players and products entering the market in the next few years to meet demand.
Why did Treasury issue these new regulations? "All Americans deserve security in their later years and need effective tools to make the most of their hard-earned savings," said J. Mark Iwry, senior advisor to the department. "As boomers approach retirement and life expectancies increase, longevity income annuities can be an important option to help Americans plan for retirement and ensure they have a regular stream of income for as long as they live."
Now it's up to 401(k) plan sponsors to step up and offer QLACs in their 401(k) plans. Many plan sponsors are waiting for employees to express interest before taking any action. If you might want to buy a longevity annuity to help you develop a retirement income strategy, politely ask your employer to offer it in your plan, and encourage your friends at work to do the same.