James Sullivan

QLAC, QLAC … Can the AFLAC Duck Help Market QLACs?

Will qualifying longevity annuity contracts or QLACs be the next big thing?

March 19, 2012
by James Sullivan, CPA, PFS

The Government Accountability Office (GAO), the Council of Economic Advisers (CEA) and now the IRS are all trying to draw attention to the value of using annuities in retirement. This includes the use of immediate, deferred and longevity annuities. In recently issued proposed regulations, the IRS coined a new term — Qualifying Longevity Annuity Contracts or QLACs. Is there a QLAC duck in our future touting the advantages of longevity annuities?  Maybe the AFLAC duck can help get the word out.

A longevity annuity in its simplest or “pure” form is purchased many years before payments under the contract begin. For example, a 65-year-old pays a $50,000 premium for a longevity annuity that begins payments when he turns 85. The monthly single life payout is locked in at the time of purchase. In this case, the owner would receive $2,500 a month beginning at age 85. For a female of the same age, the single life payment would be approximately $2,000 per month. Longevity annuities shift longevity risk away from the owner to the insurance company and the other policyholders.

The GAO, CEA and IRS Agree on the Value of Annuities

In June 2011 the GAO issued Retirement Income: Ensuring Income throughout Retirement Requires Difficult Choices. In February 2012, the CEA issued its report Supporting Retirement for American Families. Both reports advocated the use of annuities in retirement income planning.  To accommodate the purchase of longevity annuities within individual retirement accounts (IRAs) and other retirement plans, the IRS issued proposed regulations on February 3. The regulations allow the amount set aside for a longevity annuity to be ignored for purposes of calculating the required minimum distribution (RMD). Before a discussion of the proposed regulations further explanation of longevity annuities is in order.

Longevity Annuities 

A longevity annuity has attributes of both deferred and immediate annuities. The attached table shows a comparison between the three types of annuities. A “pure” longevity annuity contract offers only a life annuity payout (or joint and survivor payout) beginning at a stated age. Some longevity contracts, however, offer other features such as death benefits and term certain payouts. In many cases these additional features reduce the future payouts by as much as 50%.

If the annuitant dies before the payments under the longevity annuity are set to begin, the contract will have no value. It is a risk management tool rather than an investment. The GAO report refers to longevity annuities as a “deeply deferred annuity,” while in The Annuity Advisor (2nd Edition), authors John Olsen and Michael Kitces say on page 217:

“The benefit of the longevity annuity is that it enables her to insure against that (longevity) risk at a deep discount. Obviously an insurer can offer an annuity purchaser a far greater guaranteed income, per dollar invested if it owes nothing (if she fails to live to the annuity starting date), than if it would if the insurer were required to return the amount invested (plus interest) as a death benefit.”

Unless the payment is adjusted for inflation, the real value of the monthly payment may be reduced. For example, at 3% annual inflation, the $2,500 monthly payment in the example above is only worth approximately $1,400 at age 85. The payout is further reduced in value during the annuity period (if the annuitant lives another 10 years, the real value of the payment at death is $1,045 at 3% inflation).

Product example: One large insurance company offers a longevity policy in two versions:

Version Death Benefit Provision Payout Options Annual Payout at Age 85
$50,000 premium paid at age 65
‘Pure’ longevity protection

None Payments for life or
Joint and last survivor; no term certain payout.
Male $30,000
Female $24,000
Flexible payout options and death benefits Purchase price plus 3% annual interest paid to beneficiary if payments had not begun; if payments had begun, payments will be made until end of term certain period (if elected). Payments for life, or
Joint and last survivor, or
Life payout (or joint and last survivor) with term certain.
Male $15,400
Female $15,000

In comparison, at today’s interest rate and mortality assumptions, an 85-year-old male would pay approximately $202,000 for an immediate annuity paying $2,500 per month for the rest of his life.

Proposed Regulations

The purchase of a longevity policy with payments beginning at age 85 presented a problem, however,  in IRAs and other tax-favored retirement plans that require distributions beginning in the year following the year in which the owner turns age 70½ (RMD). The value of the longevity policy would have to be included in the calculation, meaning a disproportionate amount of the RMD would have to be drawn from the other assets.

For example, if an IRA contains $200,000 in total assets of which $50,000 is used to purchase a longevity annuity, the first RMD would be calculated based on the account’s full value of $200,000. The first year RMD would be $7,300. All of the distribution would have to come from the $150,000 liquid portion of the account, making it probable that that portion of the account (assuming an annual 4% growth in the account) will be fully depleted shortly after the owner reaches age 85, leaving the owner with income coming only from Social Security and the longevity annuity.

The proposed regulations would allow the RMD calculation to exclude the $50,000 used to purchase the longevity policy. Upon reaching age 85, the RMD would still be approximately $9,000 per year assuming an initial balance of $150,000 subject to the RMD.

The proposed regulations, however, place a limit on the amount that may be excluded. This amount is the lesser of:

  • 25% of the account balance or
  • $100,000.

The Proposed Regulations do not apply to Roth IRAs because they are not subject to the RMD rules.

In order to qualify as a QLAC, the contract must meet the IRS’s definition including a specified starting date “… no later than the first day of the month coincident with or next following the employee’s attainment of age 85.” For additional information see the Federal Register, Vol. 77, No. 23, dated February 3.

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James Sullivan, CPA, PFS, works with his wife, Janet, who is an elder law attorney in Naperville, IL.

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