Planning for a Distant Future | By Christina P. O’Neill
New Regs Help Hedge against a Longer Retirement
Last July, the U.S. Treasury issued regulations allowing qualified longevity annuity contracts as tax-deferred annuity products. The new rules allow deferment distribution of payments, within qualified retirement plans, until up to age 85, far beyond the required minimum distribution (RMD) age of 70 ½.
Now, holders of 401(k) or IRAs can use up to 25 percent of their account balance across all their retirement accounts, or $125,000, whichever is less, to buy a QLAC.
Deferred income annuities (DIA) constitute about 1 percent of total annuity sales now. AIG has been first to gain approval of its QLAC product; other so-called “manufacturers” are seeking approval to bring their QLAC products to market this summer. New York Life is one of them. Ross Goldstein, managing director of annuity business at New York Life said that the firm has seen “tremendous growth” over the last four years in deferred income annuities. The Treasury ruling will raise the profile of these products, opening up the qualified-plan market, he predicted.
In 2010, the annuity market was about $50 million; longevity products were purchased by clients in their 60s who wanted to defer income to their 80s. “People were looking to recreate a pension,” Goldstein said; they had more skills in accumulating assets than they did in planning how to take distributions.
But within the last year, the market has burgeoned to about $1 billion about a year. Goldstein notes a large concentration in nine- to 10-year income deferrals, as well as a contingent of clients who want distributions to start at 70 ½. No other investment costs less in real dollars than guaranteed income products, Goldstein said.
New York Life’s average client age is 59 for deferred-income products, and that client expects to work for another eight years until age 67. The product isn’t restricted to a one-time lump-sum payment. Clients can invest more over time, with the proviso that the payout related to subsequent contributions will be prorated over the course of the original time window. The later the contribution, the less the rate of return on payouts.
Hedging against Life Expectancy
Wendy Carter, defined contribution director with The Segal Group, headquartered in New York City, said, “As more of retirees’ income comes from defined contribution sources, the need to provide a longevity hedge will become more important. While a complex decision, a deferred option provides a longevity hedge without having to purchase an immediate annuity.”
Carter said that the dollar and percentage limits on QLAC purchases should allow many participants to purchase a reasonable amount of deferred income. However, she said, survey data shows that most close to retirement have account balances well below the $500,000 that would allow a $125,000 QLAC purchase.
Other real-life dilemmas concerning annuities come from two ends of the life-time horizon spectrum, involving the inevitable death and taxes. Investors in annuities may find, too early, that they need more cash than their current income stream supports. They’re faced with paying surrender fees and penalties – and taxes.
Also, with many DIA products, if the annuitant dies before payment starts, the investment is not refundable and heirs, if any, get nothing. The AIG product reportedly addresses the issue of loss of investment if the annuitant dies before payments begin. Treasury regulations state the death benefit is like a required minimum distribution for that year and is not eligible for rollover.
Late last year when the AIG product debuted, brokers questioned whether the investment in a qualified-plan QLAC can be converted to a Roth IRA just before the client starts drawing down. The answer: Once qualified money in a QLAC is converted into a Roth, it’s no longer a QLAC (conversely, longevity annuities bought within Roths are not considered QLACs because Roths have no RMD requirements), so the suggestion was that QLAC investors examine this issue before reaching the maximum qualified-plan distribution age of 70 ½. In essence, they may have to hedge their bets.
Also, brokers inquired who is responsible to determine that the annuity purchase meets the Treasury guideline purchase limits, and whether the QLAC originator would need to code such confirmation into its order entry system. Originators don’t have that information on hand – the IRS does.
Carter brings up another concern. In a recent article, “Helping Participants Manage ‘Longevity Risk’ in Light of the Increasing Importance of Defined Contribution Plans: New Rules Make Qualifying Longevity Annuity Contracts a Small First Step,” she noted that annuities purchased within qualified plans must use unisex mortality tables, while annuities purchased through IRAs are allowed to use gender-based tables. Because women have longer life expectancies than men, their individual annuity rates are higher than men’s by approximately four to eight percent. While group rates are usually lower than individual rates, men’s individual purchase rates may be lower than the unisex group purchase rates, Carter said in the article. “These pricing differences mean that group purchasing power, frequently referred to as institutional pricing, which is one of the key advantages of retirement plans, is reduced – or perhaps lost entirely. As a result, women generally would benefit from purchasing QLACs within the plan and men might benefit from purchasing them within IRAs.”
Rising rates of return might make QLACs more attractive for long-term investors. Also, an increased awareness on the part of younger investors of the value of a future guaranteed income stream; the earlier in their lives they invest, the less they have to invest to get a higher payout, with the potential to draw out far more than they put in.
Other QLAC approvals won't come until this summer from other annuity companies. The deadline for companies to elect to offer QLACs is January of 2016. ■
Christina P. O’Neill is editor of Banking New York. She may be reached at email@example.com.