As the relatively new resource for retirement income — called the “Qualifying Longevity Annuity Contract,” or “QLAC” — becomes more well-known, financial advisors are trying to determine whether to recommend QLACs to their clients. The result so far has been confusion about what a QLAC is designed to do and how it can be used to enhance a retiree’s confidence in late-retirement finances.
The point of a QLAC is simple. It provides an additional source of guaranteed lifetime income to retirees’ portfolios that enhances their ability to invest for growth while providing peace of mind from gaining a source of income that will last as long as they live.
RMDs vs. QLACs
One recent examination of QLACs spent much time on a discussion of RMDs (Required Minimum Distributions from an IRA account that must begin at age 70½). Since a QLAC can be purchased with savings from an IRA, some RMDs can be deferred until the QLAC payments begin, which might be as late as age 85. That could be attractive to some investors who have no need for the IRA payments to kick in at an earlier age.
However, some advisors have argued 70-year-old retirees might make more money by keeping the savings in the market, taking the earlier RMDs and paying taxes on the amount. In one example, assuming an 8% annual return on the IRA savings and receipt of after-tax RMDs, that approach would appear to be more valuable than investing $125,000 in a QLAC with payments starting at age 85. (You can purchase a QLAC before you are 70. The younger you are when you buy it, the greater the discount.)
Trust me, as an advisor and actuary, that analysis is not straightforward, particularly because you’re comparing current withdrawals vs future life contingent payments.
Balancing QLAC assumptions
Here are some questions to ask if your advisor puts forth the RMD argument.
- Are the results of the purchase of a QLAC being appropriately compared to the most conservative assets in your portfolio? A QLAC offers stable, guaranteed payments and should be compared to returns you can earn on bonds, not the stock market. (However, with a QLAC in place, you might be able to invest the rest of your portfolio more aggressively.) An 8% return assumes a 100% investment in the stock market, an unlikely assumption for an investor aging from 70 to 90 and beyond.
- Does the advisor’s model recognize the difference between investing before you reach 65, and post-retirement? There is a difference. Before 65, you are building your savings. After that, you need to consider how long your savings will last before you have to spend down your accounts, with the risk of running out of money.
- Does the comparative analysis between purchasing a QLAC and receiving RMDs take into account assumptions like tax rates early and late in retirement, the form of QLAC annuity elected, market volatility for the model portfolio, and longevity?
- Are you taking into account late-in-retirement expenses? These often involve health care costs, which can be very expensive. RMDs tend to remain flat or decrease late in life.
Some of the current criticism of QLACs is based on hypothetical yet simplistic comparisons. To understand whether you would be better off with a QLAC, it is best to consider your specific finances and situation.
Diversity always pays
Finally, look at the options that will protect you not just for a theoretical period of several years, but for as long as you live. Your retirement plan should include many sources of income (guaranteed income like Social Security, a pension, and an annuity like a QLAC) and savings that provide interest and dividends as well as equity in stocks and bonds. Our Go2Income advisors are available to discuss your investment options. We believe in educating consumers by looking at all factors specific to you — and allowing you to decide which options are best.