Would you like to make up to 25 percent of your IRA portfolio risk-free? Are you and/or your spouse in good health and do you expect to live into your late 80s or 90s? Do you not need your IRA required minimum distributions (RMDs) to maintain your lifestyle? Do you want to lower your taxes on your RMDs at age 70½ and older?
If you answered yes to the questions above, you should definitely consider Uncle Sam’s new qualified longevity annuity contract (QLAC). Government rules were issued 14 months ago, and now almost all the major insurance companies are offering QLAC policies.
Here’s how they work: You can commit up to 25 percent of your IRA, not to exceed $125,000. (To invest the $125,000, your traditional IRA assets must be $500,000 or more.) You then transfer that tax-free into a QLAC policy — a special deferred income annuity. (Traditional deferred income annuities are also called longevity insurance.) You choose a future date, not past your 85th birthday, to receive guaranteed income for the rest of your life.
If you choose the maximum age of 85, you avoid paying taxes on all those RMDs that you would have been forced to take for almost 15 years. At age 70½, the RMD is 3.65 percent, increasing to 6.76 percent at 85. (It doesn’t exceed 10 percent until 93 and reaches 20 percent at 104. However, it is an outrageous 52.6 percent at age 115 or older.)
The obvious candidate for a QLAC is someone who expects to outlive the average lifespan — the average 65 year-old female lives to age 85.5 while the average male at that age reaches 82.9. However, there is a 50-50 chance that one of the married 65-year-old spouses will reach 89 and 18 percent odds that one will survive until 95.
Let’s use an example: My healthy 78-year-old wife Sue is a classic candidate for a QLAC. Her mother died at 99, father at 95 and she had grandparents and great grandparents who lived into their 90s.
We plan to allow her IRA to grow, then buy a QLAC from New York Life for her before she reaches 80 in 2017. Using the current New York Life maximum single-life projection payout — likely to be higher as interest rates and dividends increase — she would receive $20,460 a year for the rest of her life!
My two favorite life insurance companies are New York Life and Northwestern Mutual, two of the three leading companies offering deferred income annuities.
Both get the highest possible ratings from the four major insurance rating agencies and both are non-stockholder owned mutual companies.
Simply put: When an insurance company’s income exceed expenses, mutual companies such as Northwestern and New York Life reward policy holders with higher dividends while shareholder-owned insurance companies’ profits accrue to investors who own their shares.
Suppose a 66-year-old man (full Social Security retirement age) retires with $400,000 in his 401(k), rolls it over to his IRA, and decides to put $100,000 (the maximum 25 percent) into a QLAC. He then typically has to make two crucial choices: (1) when does he want to start income and (2) does he want to max out his income with no guarantees?
We’ll assume he’s in great shape, won’t need all his RMDs when reaches 70½, and his parent and grandparents have good longevity. He therefore chooses the maximum age 85 as a starting date. (He can always change his mind and start it earlier.)
He must decide whether he wants the maximum payout without guaranteeing any return of principle and, if married, should he opt for payments to his wife if he dies first. If he chooses the straight single-life option at NY Life, the current projected payout would be $55,243 annually or about $4,603 monthly.
However, he may decide he wants a money-back guarantee and/or having income paid to his wife for the rest of her life if he dies first. He can choose a single-life option with his heirs receiving the $100,000 if he dies before 85 or they would get any amount left if he did not receive the full $100,000 in pay outs. NY Life projects he would then receive only $35,208 yearly, or $2,934 a month.
Of course, if he wants his wife, who in this example is also age 66, to receive payments after he dies, the amounts drop a great deal. The joint life guaranteed $100,000 back option is $25,954 annually while the no-money-back joint life policy pays out $31,950 a year.
You can see payouts for various options at different companies at www.go2income.com/qlac. Female QLAC policies pay less than men’s given that women live longer. (Also check out the excellent QLAC article: “How to Keep the IRS Waiting,” Kiplingler’s Personal Finance, 10/2015, p. 31.)
Unfortunately, Northwestern Mutual doesn’t allow QLACs to be set up for anyone after age 75 while NY Life’s starting date is age 80 or younger. (NY Life’s minimum to start is $5,000 with minimum additions of $100 monthly.)
The tax-savings from not taking RMDs from IRA money placed in QLACs obviously ends when the payouts begin. However, remember that the larger income from QLAC payouts can be used to offset RMDs required from any other traditional IRA accounts. (Roth IRAs have no required RMDs and are not appropriate for QLACs but may be a good no-risk option for traditional deferred income insurance contracts.)
Certainly, I believe stock market investments will handily beat insurance contract returns over the next decade or two or three.
However, substituting a QLAC for the portion of your IRA normally invested in bonds is, I believe, a superb choice. Given their no-risk status, lifetime income, and tax savings until income begins, there is no question that QLACs deserve serious consideration from healthy seniors who have traditional IRA accounts.