Q: My financial advisor recently suggested I buy an annuity. He said it would help make sure I don’t outlive my assets. I was surprised by the recommendation because I have always been told to avoid annuities (they are expensive and illiquid, etc.). I’m in my late 50’s and I would like to get ready for retirement. Can an annuity help?
A: Generally, I would have the same reaction as you. However, a certain type of annuity might make sense in your situation—something called a Qualified Longevity Annuity Contract or QLAC. However, before we get into QLACs, let’s talk about longevity risk.
One of the biggest risks retirees face is the prospect of outliving their assets. We call this longevity risk.
A 2011 survey by the Society of Actuaries, found that 79 percent of retirees estimated their personal life expectancy to be shorter than actuarial estimates. Over half of the under-estimators missed by more than five years. If you believe the actuaries, a lot of people are going to be surprised.
For most of us, living longer than expected sounds like a “first world” problem. However, unless you properly plan for it, longevity can lead to serious complications. Nobody wants to be 90 years old and broke.
Want a reality check on your own life expectancy assumptions? On a slip of paper, write down how long you expect to live. Next, go to the website Livingto100.com and click on the link to “Take the Calculator.” The calculator will ask you 40 simple questions about your health and family history and will give you a scientific estimate of your life expectancy. I did it and found out I was just like everybody else—I underestimated my life expectancy by five years. But I digress. Let’s get back to QLACs.
One way to protect against longevity risk is with a Qualified Longevity Annuity Contract. A QLAC is a deferred income annuity purchased in a traditional retirement plan like a 401(k), 403(b), or traditional IRA. In exchange for a lump sum payment today, an insurance company promises to pay you a fixed monthly income for the rest of your life beginning at some point in the future.
One of the best parts about QLACs is that money invested in a QLAC is excluded from required minimum distributions when the IRA owner reaches age 70 ½. However, to receive this benefit, the annuity must conform to a few specific requirements.
First, the annuity must be a fixed annuity, meaning it pays a certain fixed amount every month. Variable annuities or index annuities are not allowed.
Second, the annuity payouts cannot begin before you turn 70 ½ years of age and must begin no later than the month following your 85th birthday.
Third, the amount you can invest in a QLAC is limited to the lessor of 25% of the combined value of your 401(k), 403(b) and IRA assets (including existing QLAC purchases), or $125,000.
Be aware that once money goes into a QLAC, you are locked in. You will receive no payment before the contractual start date and the amount of your payout won’t change.
My final point on QLACs: While they may fit into a well-developed financial plan, they are only a part. To know if this is right for you, you need to see how it fits with the rest of your retirement strategy.
Steven C. MerrellMBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA93940 or email them to firstname.lastname@example.org.