If you’ve been reading my blog, by now you already know Longevity Annuities are a unique way to “insure” your retirement by providing a guaranteed lifetime income starting at an age you select.
The newest player in the annuity marketplace is the Qualified Longevity Annuity Contract, or QLAC, and it provides very specific tax benefits. (To learn more about what QLACs are, check out “What Every Baby Boomer Should Know – Introducing QLAC.”)
Let’s delve into the value of the tax benefits QLACs provide. Intuitively one would expect significant savings by reducing the required minimum distributions (RMDs) from your retirement plan by 25%. This is because the investor is deferring not only the interest or investment return, but also deferring the principal (which the investor was previously available to deduct).
To point out the taxes on principal, I often ask knowledgeable people in the field, “What’s the rate of return on the IRA’s RMDs if: (1) the investments earn, say, 3%, and (2) the 65-year-old investor lives to age 95?”
Cutting to the chase, the answer is around .5% after tax. This means the investor barely gets his or her money back after tax.
It’s then that investors suggest they don’t have $500,000 in an IRA account. It’s really closer to $350,000 when recognizing those deferred taxes.
With QLAC, to determine if there is real tax value in it for investors, a number of factors must be taken into consideration. For example, if a 65-year-old male lives to the age of 90, then the rate of return is 2.5%. Living another 5 years increases the return to around 4.5%. Remember that these are after-tax returns, so you’re at least getting a return on your money.
Furthermore, increasing your after-tax return by nearly 4% from .5% to 4.5% on essentially risk-free investments is unheard of in financing. Of course, this is true at a survival age of 95, but that is when you want the best results.
Far too often, people underestimate their lifespan, and think that their traditional investment portfolio is going to provide a secure source of income throughout their golden years. Unfortunately, it’s rarely the case. Either they outlive their portfolio or the investments don’t perform as well as anticipated, and the investor is left short of funds.
With IRA regulations permitting QLAC, retirees can feel confident in the tax advantages, knowing that this retirement vehicle will address their longevity needs in a way that other investments simply can’t.
If you want to play with some real numbers to see how a QLAC might impact your retirement income, visit our Go2Income Toolkit and use the QLAC calculator you find there.