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Articles, wit and wisdom about retirement planning, tax management and living a long life.


A No-Regrets Retirement Guide for Procrastinators

 It is utterly false and cruelly arbitrary to put all the play and learning into childhood, all the work into middle age, and all the regrets into old age.  -- Margaret Mead

In your fifties or sixties? 

If you’re like most people our age, you may have a regret or two. 

Research by Cornell Psychology Professor, Thomas Gilovich, shows what we regret most in life is not the mistakes we’ve made in the past. Instead, the things we didn’t do produce the most regrets. It turns out that we regret the most are the times we failed to act.

Regrets and Retirement Planning

Nowhere is this truer than in retirement planning. For most of us, our regrets span both saving for retirement (never enough) and failure to manage our retirement once it has started.  

Rare is the individual who can say that they have it completely together in planning and managing their retirement.  If you feel this failure applies to you, it turns out you are in good company. A 2018 Northwestern Mutual study found that 21 percent of Americans of all ages have nothing at all saved for the future. Another 10 percent have less than $5,000 saved for their golden years. A 2017 study by Government Accountability Office (GAO) analyzed retirement savings.  The study found the median retirement savings for Americans between age 55 and 64 were $107,000.  The reasons for our nation’s savings shortfalls are as varied as people themselves. Examples include: 

  • Failure to get into the retirement savings habit;
  • Unexpected and uninsured loss of an income provider;
  • Divorce; 
  • Protracted family illnesses; 
  • Education expenses or debt; 
  • Investments that have gone awry. 

Professor Gilovich would tell us that no matter what the reasons are, they don’t matter now. What is important is what happens next. Professor Gilovich advises that we tackle our potential future regrets head-on. “As the Nike slogan says: ‘Just do it’; Don’t wait around for inspiration, just plunge in. Waiting around for inspiration is an excuse. Inspiration arises from engaging in the activity.”

How to “Just do it” for your retirement?

What follows is a short guide to “just doing it.”

1. Start by calculating retirement assets and income. Your first step should be to look at your financial situation with the long view in mind. First, add up your existing assets. Factor in social security (click here to see the social security administration’s benefits estimator). The benefits estimator tool may provide you with some important insights into how long you will want to keep working. For example, while you may start to receive Social Security at age 62, you should study your options. The Social Security Administration pays a smaller benefit to people who begin receiving payments at age 62. It pays more, for example, to people who wait until age 66 or age 70. If you enjoy what you are doing, are in good health, and can keep working, you may enjoy receiving benefits later. Indeed, Social Security benefits increase every month you do not take them until you reach age 70. After a retiree’s 70th birthday, there is no economic benefit for continuing to wait. For more on this topic go to the Social Security Benefits Planner. You may also find useful an article about the tradeoffs between taking early and late distributions in this article by the Motley Fool.

2. Project Living Expenses in Retirement. You need to look at what you are going to need in retirement to cover your expenses.  Be sure to include rent, food, medical expenses and other costs of day-to-day living. If there is a shortfall – and there is for many of us – don’t panic.  No matter how small your savings is now, the most important thing you can do at this stage is to begin. Start by projecting what your expenses are. 

3. Start Problem-solving. Here are some examples of places in your budget where you can find money:

a. Save on Housing Expense. A smaller home or apartment may make sense now.  Many of us with grown children live in houses that are far too large for our needs.  Moving to a smaller home in a different state, county, or even a school district can be liberating. Such a transition can mean less monthly living expense and less day-to-day maintenance. Often, the result is a net improvement in the quality of life.

b. Save on Debt. This time of life is often a great time to pay off credit card debt built up over the years.  Helping your kids through their various stages in life can create credit card debt.  Debt consolidation either using home equity or other forms of credit can make sense. Also, it may be a good time to explore refinancing to a 15-year mortgage. A fifteen-year mortgage may move you to a net higher payment. Paying off your mortgage in your fifties and sixties paves the way to rent-free living in your seventies and eighties. Even more enticing, after age 62 a reverse mortgage becomes an option. 

c. Save on Day-to-day Expenses. Don’t be ashamed to grab senior discounts, they are everywhere. Look for them in grocery stores, movie theaters, ballparks, hotels. Finding and using these discounts can become a part of your routine. To get you started, here is a list of senior discounts

d. Consider Small Investments that Reduce Your Living Expenses. For example,  you can reduce your electricity costs. Many states provide incentives for residential investments in solar power and geothermal heating and cooling. The Federal Government also provides an investment tax credit for these kinds of investments.  Start a garden. If you spend a lot of money watering on your property, a humble rain barrel can provide decades of savings on irrigation.

e. Consider Working Longer. For those who are able, keeping working post-retirement is a sensible way to fill up the savings tank. This may mean a transition to a second career which may be different from what you pursue in the present. For example,  after working many years in larger companies, you may move to more entrepreneurial endeavors. Self-employment means never having to face mandatory retirement! Whatever you choose, remember that you have many, many life skills you can leverage.

f. Increase Retirement Savings as You Can. There is good news from the US government. Believe it or not, Uncle Sam has created incentives for you to save in your later years. Provisions for retirement planning procrastinators include “catch-up contributions.” The catch-up contribution provides for accelerated retirement savings after age 50. The limit for employees aged 50 and over who take part in 401(k), 403(b), most 457 plans and the federal government’s Thrift Savings Plan (2019) is $6,000. The catch-up contribution limit for individuals aged 50 and over to the Individual Retirement Plan is $1,000. To learn more follow the link to IR-2018-211 released by the Internal Revenue Service on November 1, 2018.

g. Reduce your Medical Expenses with Medicare. If you are within three months of your 65th birthday, you can sign up for Medicare. Medicare is the national health insurance program for people age 65 or older. Part A helps pay for inpatient care in a hospital or skilled nursing facility. Part B helps pay for doctors’ services and many other medical services. Most people age 65 or older are eligible for free Medicare hospital insurance (Part A) if they have worked and paid Medicare taxes long enough. You should sign up for Medicare hospital insurance (Part A)  3 months before your 65th birthday.  Sign up even if you do not want to begin receiving retirement benefits at that time. Anyone who is eligible for free Medicare hospital insurance (Part A) can also enroll in Medicare medical insurance (Part B).  You enroll in part B by paying a monthly premium. Some beneficiaries with higher incomes will pay a higher monthly Part B premium. If you do not choose to enroll in Medicare Part B and then decide to do so later, your coverage may be delayed and you may have to pay a higher monthly premium. To learn more about Medicare, follow this link to the Social Security Administration’s Medicare Page

h. Postpone Income and Required Minimum Distributions. As of January 1 2020, retirees who reach the age of 72, have until April 1 of the next year to take their first Required Minimum Distribution (RMD) from their qualified retirement plan(s).  They have until the next December 31 to take their second distribution. Those individuals whose employer retirement plans allow it and who may continue to work after their 72nd birthdays may wait until the year they retire to take their first Required Minimum Distribution. For more on this topic see the IRS Topic Page on Required Minimum Distributions

i. Use a Qualified Longevity Annuity Contract (QLAC) to Cover Income Needs in Later Retirement Years. For many, retirement funds are limited. If you are concerned about outliving your retirement assets, a QLAC is a great way of assuring yourself income later in retirement.  QLAC income must begin before you reach your 85th birthday but can last for the rest of your life. Click here to watch a seminar by QLACguru Ray Ryan describing this strategy then try our Failsafe (sm) Maximize Income Calculator to see how this strategy might work for you.

j. Mark your Calendar. Retirement is not a single event, but a process to be managed. To get started, follow the link to Calculate the important future dates of your retirement. Start studying your options and setting goals.  Be prepared to address each of the milestones as they arise at age 50, 55, 62, 65, 70 and 70 and one-half. 

Once you’ve done this homework, it may be time to hire on a financial advisor to help you grow your assets. But pick her or him carefully. Like Charles Barkley, you need to, “take the shame out of your game.”   Never allow a prospective advisor to ridicule the size of your portfolio. If he or she does, find another who won't.

After all, it’s not about what you have now, but what you can have in the future.  

Welcome to the next 30 years of your life!

Want to learn more? Check out our videos page to see additional QLACguru videos.  See our calculators page to develop an anonymous RMD calculation and estimated QLAC quote. Answer specific questions by going to our Knowledgebase page.  Visit our blogs page for in-depth articles on a variety of topics including how QLACs help with sequence Sequence Risk, how QLACs are similar to and different from Social Security, as well as many other topics. Free Consultation.  If you would like us to develop a free RMD analysis and illustration of how a QLAC might work for you, please click here.

What Is Sequence Risk in Retirement?

Summary

Retirees that are withdrawing assets from savings during retirement are particularly vulnerable to a year or years with market losses.  The name of this vulnerability is “Sequence Risk.”  Using examples, this article shows why and how “Sequence Risk” hurts retirees.  Also, the examples show how traditional countermeasures perform in today’s world.  Finally, there is a measure of how a Qualified Longevity Annuity Contract helps reverse the negative consequences of “Sequence Risk.”  Possibly even more important, we show how a QLAC also eliminates benefit longevity risk for the retiree.  She or he cannot outlive her or his respective savings with a QLAC.

Introduction

Is “Sequence Risk” a concern for those retirees who depend on their IRA and other defined contribution savings plans?  The answer is, yes -- particularly for those individuals that are concerned about outliving their savings. 

What is Sequence Risk?  It is the risks that during the early years of retirement, the invested savings will be subject to a market decline such that the losses will reduce the amount of long term retirement benefits available to the retiree.

An example will demonstrate this phenomenon.  Let us assume a retiree with an IRA account with $200,000 in it. He plans to withdraw $8,000 a year during his retirement.   Under the Alternative, I scenario, his rate of return equals his withdrawals[1].  As a result, his account balance remains unchanged during the years below.

 

Alternative I

Year

IRA Account

Rate of Return

Earnings

Benefit Withdrawal

Y/E Balance

1

$200,000

4%

$8,000

<$8,000>

$200,000

2

$200,000

4%

$8,000

<$8,000>

$200,000

3

$200,000

4%

$8,000

<$8,000>

$200,000

4

$200,000

4%

$8,000

<$8,000>

$200,000

 

Under Alternative II below, the individual retires in a year with a market correction of 20%.  In the following year, there is an additional 10% decline in value.  While in years 3 and 4, there is a bit of recovery, the retiree has lost almost 37% of his investment capital.   Even if his average rate of return comes back to 4%, it is highly unlikely that the Alternative II retiree will recover the lost $37.000.  As a result, his benefit withdrawal capacity is at risk while he ages.

 

Alternative II

Year

IRA Account

Rate of Return

Earnings

Benefit Withdrawal

Y/E Balance

1

$200,000

<20%>

<$40,000>

<$8,000>

$152,000

2

$152,000

<10%>

<$15,200>

<$8,000>

$128,800

3

$128,800

4.5%

$5,800

<$8,000>

$126,600

4

$126,600

6%

$7,600

<$8,000>

$126,200

 

In other words, because a Sequence Risk event took place in the first two years of retirement, he may well outlive his IRA savings.

Guarding Against Sequence Risk

Between 1973 and 2008, there were seven annual downturns that exceeded negative 10% in the S&P 500 index.  The average annual loss exceeds 20% for these seven loss years.  While the current stock market has enjoyed an extended and remarkable growth, significant corrections often follow such periods of stock appreciation.   Accordingly, Sequence Risk is as much of a concern today as it has been for any time in the past. 

Retirement planners have a variety of strategies to insulate and protect retirees from Sequence Risk:

  • Limit annual withdrawals to 4% of the remaining investment corpus;
  • Create a bond “ladder” - purchase of a series of bonds that mature annually and which fund the withdrawal needs of the retiree for a period of 7 or more years.  The non-bond assets are invested in equities.
  • Invest in bonds in proportion to one’s age.  In other words, a 70-year-old would invest 70% of his or her portfolio in bonds – the remainder in equities.

More recently, the Qualified Longevity Annuity Contract (“QLAC”) has become available and is a useful tool to reduce or eliminate the negative consequences of adverse market sequence event(s).

 

A Case Study

 

Examples are often the best way to see how a financial program works.  In this case, our IRA owner, Maria, has $200,000 in her IRA[2] at the calendar year end when she is 69. She will retire at 70 and wants her IRA to supplement her social security benefits. Together the two funds flow should equal or exceed her cost of living. During Maria’s retirement, she plans to invest the funds remaining in her IRA and wants to feel comfortable that she will not outlive her retirement assets.

 

Projecting Investment Returns

To project equity returns, our example looks at the S&P Index performance for the 10 years beginning October 1, 2007, and ending September 30, 2017. We assumed that the S&P Index returns are a reasonable surrogate for equity investing.   Also, this period conveniently begins with a sequential loss.  The fiscal returns for the year ended September 30, 2008, are a 24% loss.  The fiscal year ended September 30, 2017, enjoyed a 16% gain. The annualized rate of return was 5% for those ten years. To project returns from age 70 to 110, the same sequence of returns was repeated four times (the “S&P Forecast”).

Another illustration was prepared to assume a simple 5% return on assets in every year.  That way, we can measure the effect of adverse sequence experience.  Below is a table that compares the S&P Forecast and the constant 5% return. (To see the detailed projections behind these summaries, click on the related hyperlink in each of the tables below.)

Illustration

Burn-out Age[3]

Total Distributions

Average Annual Distribution

I. 5% Annual Return

104

$467,000

$13,331

II. S&P Forecast

92

$265,000

$11,287

 

There is a significant detriment embedded in the adverse sequence experience of the S&P Forecast.  Losing 24% in the first year is never made up by 17% and 16% returns in later years.  The S&P Forecast runs out assets in 22 years – the 5% annual return alternative lasts another 12 years – more than 50% additional years.  Sequence Risk, indeed, matters.  See Graphic 1.


Next, we wanted to see what relief bond investments might offer.  Yields today on bond purchases are low.  We looked to current returns in the two most substantial bond funds for guidance: 

Name

ETF Symbol

Total Assets

30-Day SEC Yield

Vanguard Total Bond Market

BND

$36.9 Billion

2.65%

iShares Core US Aggregate Bond

AGG

$52.3 Billion

2.37%

 

We also noted that 5 year and shorter Treasury notes all have returns less than 1%.  To do a modified bond ladder, year one bond yields were assumed to increase 1% each year to equal 3% in the seventh year. Thereafter, the bond yields were set at 3% each year.  These bond return assumptions are high to avoid any bias in favor of the equity return assumptions.

John Bogle, the founder of Vanguard, is a strong proponent of holding bonds in an investment portfolio.  His recommended percentage of bond holdings ranges from 40% to 75%, depending on the age of the investor.  Accordingly, we prepared illustrations where a participant invested in a combination of bonds and the S&P (the “Combo” investment).  The investment ratio is a constant 70% bonds and 30% S&P index – both as described above.

Withdrawals from the IRA

Our retiree, Maria, wants to know how much she can withdraw from her IRA and how long her IRA will provide adequate income to supplement her social security benefits.   Her calculations suggest that $9,000 of annual withdrawals is a minimum for her needs.  Since the Federal Reserve Bank is targeting a 2% rate of inflation – ideally, her withdrawals can include an annual increase for inflation. Let’s look at three withdrawal scenarios:

  • The retiree withdraws 4% of prior year end’s IRA assets each year.
  • The annual withdrawal equals $9,000 each year plus any amount needed to equal the RMD.
  • The withdrawal equals $9,000 plus a 2% annual growth rate (RMD is not triggered).

 

Strategies for Limiting Sequential Risk

Let’s see if the 4% rule and the Combo help to offset the loss of benefits due to Sequential Risk.

The 4% withdrawal rate enables the assets to last to age 110 and beyond. Still, between ages 71 and 77 inclusive, the 4% amount is less than $8,000 per annual – far less than the needs of Maria.  Starting at age 73, the 4% rule is not relevant. (See the Appendix, Illustration III.)  The RMD amount is larger.  When it comes to offsetting Sequential Risk, the 4% rule has little to offer an IRA owner. Merely taking the RMD required each year will give an equivalent and volatile result. 

The Combo approach certainly reduces the volatility of Maria’s investment returns.  Also, the Combo investment has more assets in the early years than a straight S&P Forecast.  The RMDs are less than the Combo withdrawals in the early years – allowing the Combo approach to compound its asset basis while the S&P Forecast is struggling to catch up.   Still, the Combo investment approach only adds one more year of distributions.  

See the chart below:


Illustration - $9,000 Fixed

Burn-out Age3

Total Withdrawals

Average Annual Withdrawal

IV. Combo Return

104

$319,000

$9,124

V. S&P Forecast

103

$311,000

$9,145

 

In both investment alternatives above, the Average Annual Withdrawals are higher than $9,000.  This arises because in various years after age 85 the RMD is higher than the planned for withdrawal of $9,000.

If Maria adds 2% inflation to her annual withdrawals, her assets run out 11 years before restricting withdrawals to a flat $9,000.  Also, her scheduled withdrawals will always exceed RMD.  See Graphic 2 and the chart below it.



Illustration - $9,000 Plus 2% Inflation

Burn-out Age3

Total Withdrawals

Average Annual Withdrawal

VI. Combo Return

93

$274,000

$11,408

II. S&P Forecast

92

$260,000

$11,287

 

Qualified Longevity Annuity Contract (“QLAC”)

Maria conceded that mixing bonds and equities can protect against Sequence Risk of a straight equity investment. Still, she had hoped for more than one or two additional benefit years.  As a result, Maria decided to see what if any benefit a QLAC might offer.

Her research revealed that if she buys a QLAC with a start date of age 85, the lifetime annual annuity equals 36.5% of the premium.   That single life annuity will be $12,775 per annum if she pays a premium of $35,000.  Since the legal limit on premiums is 25% of her IRA balance of $200,000 (i.e., $50,000), Maria is well within the legal parameters.   Maria can withdraw the $35,000 from her IRA without it being treated as taxable to her.  Also, the withdrawal reduces the IRA assets used to compute the RMD of her residual IRA balance.

Maria looked at a QLAC premium of $35,000 coupled with her preferred withdrawal scenario ($9,000 plus 2% inflation). Even after reducing the IRA account by the QLAC premium, the IRA account still has assets after 15 years of benefit withdrawals. The Combo has $45,000, and of course, the S&P Forecast has less - $10,000.  After age 84, these IRA balance amounts are then amortized by the RMD requirements and are in addition to $12,775 QLAC annuity beginning at age 85. Below is a summary chart of the performance of the QLAC choices:  

 

QLAC Illustration - $9,000 Plus 2% Inflation

Burn-out Age3

Total Withdrawals Thru Age 110

Average Annual Withdrawal

VII. Combo Return

Never

$554,000

$13,523

VIII. S&P Forecast

Never

$504,000

$12,283

 

Again with a QLAC, the Combo route is able to generate higher annual benefits than pure equity returns where adverse Sequence Risk is experienced.

Still, what Maria finds attractive is that she does not have to reduce her targeted income needs to purchase a QLAC.  With a QLAC, she can still withdraw amounts dictated by the $9,000 plus 2% formula.   By year 15 (when she is 84 years old), her inflated withdrawal will increase to $11,875.  Starting at age 85, the QLAC annuity kicks in to pay her $12,775 per annum plus the RMDs triggered by the assets remaining in the IRA. The $12,775 annuity will last as long as she does.  See Graphic 3.


Studying these results, Maria recognizes that her focus on Sequence Risk was an embedded concern that she would outlive her assets.  Mixing debt and equity investments can reduce Sequence Risk, but it will do little to address longevity risk – unless she dies before 90 or substantially reduces her lifestyle and expenditures in retirement.  With a QLAC purchase, she can convert the tail end of her retirement into a defined benefit plan where it is not possible to run out of benefits.  Even better, she can create a plan (with a QLAC) where the average annual withdrawals are projected to exceed those of an IRA without a QLAC.

For Maria, a QLAC makes a lot of sense – it helps to reduce Sequence Risk and eliminates longevity risk.  It meets her retirement planning objectives.

Want to learn more? Check out our videos page to see additional QLACguru videos.  See our calculators page to develop an anonymous RMD calculation and estimated QLAC quote. Answer specific questions by going to our Knowledgebase pageVisit our blogs page for in-depth articles on a variety of topics including how, how QLACs are similar to and different from Social Securitybest practices in buying a QLAC as well as many other topics. Free Consultation.  If you would like us to develop a free RMD analysis and illustration of how a QLAC might work for you, please click here.



[1] For simplicity purposes, the example ignores the IRA Required Minimum Distribution (“RMDs”) requirements of the IRS.

[2] A traditional IRA is assumed and accordingly, is subject to the RMD distribution rules.

[3]  The “Burn-out Age” occurs when the IRA beneficiary can no longer withdraw the projected benefit.  Smaller amounts may be payable for one or two years after the “Burn-out Age”.

 


How to Never Run Out of Money In Retirement

ABSTRACT:

The “Failsafe” Strategy is a way to manage a traditional (not Roth) IRA account so that the IRA assets provide income to a retiree for life, no matter how long he or she lives.  The Failsafe Strategy assures the person cannot outlive their IRA savings.

This retirement planning approach employs a new type of life annuity called a Qualified Longevity Annuity Contract or “QLAC.”  If an annuity meets the IRS definition of a QLAC, IRA distributions taken to pay the QLAC premium are not taxable to the recipient.  The QLAC annuity start date can be deferred to age 85 of the beneficiary.

To implement the Failsafe Strategy, an IRA owner purchases a QLAC, then divides retirement into two planning phases:

  • Phase I - From the start of retirement to the date before when the QLAC annuity payments begin (e.g., from 70th birthdate up to 85th birthday).  During this period, the IRA owner withdraws funds from their IRA in approximately equal monthly installments until the IRA balance is nearly dissipated.
  • Phase II - Beginning at the QLAC annuity start date to date of death (e.g., 85th birthday until the age at passing).  During this Phase, the QLAC takes over providing retiree income. The IRA owner receives monthly QLAC annuity payments until they die.

For many IRA owners, the maximum allowable QLAC premium (the lesser of 25% of IRA assets or $135,000) can buy a QLAC lifetime annuity with a benefit greater than or equal to the Phase I IRA payments. Thus, with proper planning, benefits received during Retirement Phases I and II can, when combined, create a level, secure, lifetime stream of income, one that the benefit recipient cannot outlive.  To see how the strategy outlined above might work for you, try the QLACGuru FailsafeSM Maximize Income Calculator Page.  If you prefer a pencil and paper approach, click to see Maximize Income Infographic on how to estimate  FailsafeSM income.

ARTICLE TEXT UDATED 11/4/2020:

This article describes a strategy that assures that a retiree will never run out of money during his or her retirement, no matter how long retirement lasts. The strategy will be outlined by following a prospective retiree, Ian.  

Ian’s retirement savings are in an Individual Retirement Account (“IRA”)[1]. Ian’s IRA includes funds that his employer contributed when it converted its pension plan from a defined benefit to a defined contribution plan.  Of course, Ian will collect social security benefits, and they are the foundation of his retirement income.  Unfortunately, Ian’s annual social security payments of $30,000 fall short of meeting his estimated cost of living of $50,000 to $60,000 per annum. 

Ian has been a hard worker all his life but never could save a large sum of money. He attempted to be an investor by buying and selling homes in addition to his day job. That effort turned into a major loss in 2008. His wife is deceased, and he has two grown children – one in the Armed Forces and the other a teacher.  Ian also has one grandchild. He owns his home, which is subject to a modest mortgage. He is 69 and plans to retire next year.  Ian has deferred his social security benefits until in the coming year.  His IRA account balance is $500,000.

Four Percent Rule In Current Environment

Fortunately, Ian is on good terms with his brother-in-law, Fred, a CPA.  Fred agreed to sit down with Ian and see how to make his IRA last a lifetime.  First, Fred relayed that there is an old rule of thumb that says that it is safe to withdraw 4% per year from your IRA and not run out retirement money.  For Ian 4% equals $20,000.  Adding the $20,000 to the $30,000 of social security benefits, Ian has $50,000 of spending money - the low end of his estimated retirement needs.  Unfortunately, Fred added that the old rule of thumb was conceived in an era when interest rates were much higher than today.  The conventional wisdom is that retirees should weight their investments towards bonds and other interest income investments to avoid the volatility of equities. Today, prudent planning suggests assuming a 2% rate of return in the IRA during retirement.  With that rate return, Ian’s IRA will be reduced to zero shortly after he reaches age 100.  Ian asked what would happen if the annual IRA withdrawal was $30,000.  For example, inflation could occur, and Medicare is likely to become more expensive; besides, he wants the extra $10,000 each year. 

If the annual IRA withdrawal increases to $30,000, Fred said, the IRA balance would go to zero by age 89.  When Ian seemed relieved, Fred pointed out that current mortality projections show Ian with a 50% probability of living to age 89 or older.  That means there is a reasonable chance Ian will outlive his IRA savings if he withdraws $30,000 annually.   Fred’s advice at this point was for Ian to look at his expenses and determine where he can cut back. It would not be prudent to take more than $20,000 a year out of his IRA during Ian’s retirement unless or until the IRA earnings exceed the projections.

Fred's 'Failsafe' Idea

The following week, Fred called Ian to say that he had an idea.  In his professional reading, Fred had run across a new insurance product, a Qualified Longevity Annuity Contract or “QLAC” for short. Further, there are more than a dozen life insurance carriers offering QLAC annuities. When an annuity contract qualifies under the IRS rules as a QLAC, an IRA withdrawal is tax exempt if used to pay a QLAC premium. QLAC annuity payouts can be deferred as late as age 85 and once begun, must be paid for the life of the beneficiary.  The QLAC distributions are fully taxed to the beneficiary but only when paid. The premium amount is limited to the lesser of $135,000 or 25% of the IRA balance.  Multiplying 25% times Ian’s IRA balance of $500,000 is $125,000, the maximum contribution limit.   (The $ 125,000-lifetime limitation was increased to $135,000 on January 1, 2020, and will increase from time to time after that.) If Ian were to buy a QLAC and defer the payment start date until his age 85, the annual QLAC benefit from a leading insurance agency quoted online would be $33,333 for the rest of Ian’s life. 

Running the Numbers

Once Ian turns 85, the $33,333 annuity is greater than his projected $30,000 income needed to top off his Social Security income. Accordingly, the question is what kind of distribution can the IRA support before age 85?  In other words, with longevity risk eliminated after age 84 by the QLAC insurance contract, Ian can focus on the remaining IRA assets[2] of $375,000.  These assets do not have to support an uncertain lifetime of income, but instead, provide retirement income for a time certain of 15 years - from age 70 through 84.  If the post QLAC IRA balance (i.e., $375,000) earns no income, $25,000[3] can be paid annually until age 85.  A 2% earnings rate in the IRA would justify a $30,000 annual distribution in each of the 15 years.  Ian has met retirement income targets and is assured of an income for life in addition to his Social Security benefits.

Ian asked, Fred, what is the catch?  Why not adopt this “Failsafe” strategy?  Remember that the annuity is a lifetime payout, Fred replied.  After you die, the QLAC payments stop. Most likely, there will be nothing left over for your children.   It is possible to buy a QLAC that guarantees a return of the premium (e.g., Ian’s $125,000 premium) even if you die before scheduled distributions.  Of course, such an annuity pays a lower benefit than a QLAC without a guaranteed return of premium.   In the event of premature death, it might be tempting to label a QLAC as a poor investment.  When a person thinks about a QLAC as an insurance contract that prevents you from running out of money in your old age, it makes a lot more sense.  A QLAC is more like a social security benefit than it is like buying a 20-year bond. 

Learning About QLACs - Who Should Buy, Who Should Avoid?

Next, Ian wondered – why have I not heard of this before? Shouldn’t everyone buy a QLAC? To begin, Fred said, QLACs were created by a Treasury Regulation promulgated in 2014.  It is a new financial product with special tax benefits. People are just beginning to learn about QLACs.  Also, not everyone is a good candidate. First, those folks without an IRA or similar savings accounts are simply out of luck.  The QLAC premium amounts must come out of an IRA or a similar tax-qualified savings account1.  Secondly, individuals with serious health concerns are unlikely candidates for a QLAC.  Presumably, persons in poor health or with a limited expected life span will choose not to participate even though carriers will happily take their premium dollars.  Finally, QLACs are not necessary for individuals who have ample savings and have no concern about running out assets.  Their incomes equal or exceed their spending needs. Most often, these individuals will be planning how their assets are to be distributed upon their passing. On the other hand, QLAC buyers are concerned about their financial resources disappearing in their old age and becoming a burden on their children.  

Ian asked Fred about the IRA required minimum distribution rules and how they might affect the Failsafe strategy.  Ian had heard that once a person reaches age 72, there must be a minimum distribution from the IRA or severe penalties are imposed by the Internal Revenue Service (“IRS”). The IRS rules divide the life expectancy of a person into the prior year’s IRA balance.  The product is the Required Minimum Distribution (“RMD”).     Because Ian is making the IRA distributions over 15 years instead of a lifetime, each of Ian’s withdrawals will exceed the RMD for each year through age 84.   The QLAC payments occur outside the IRA, so they do not affect the RMD test. Of course, if Ian’s IRA outperforms the 2% assumption, there will be a balance in the IRA at age 85, and that balance will be subject to the RMD test.  It is important to note, however, that there is no IRS penalty for withdrawing more than the RMD or even the entire IRA balance.  

Shop Around to Buy Best Benefit and Ratings

Fred told Ian there are multiple planning opportunities Ian should evaluate before he decides to purchase a QLAC.  This is because a QLAC purchase cannot be undone once contract elections are made and the premium is paid[4].  For example, his QLAC annuity could be decreased by reducing the premium and leaving more money in the IRA.  While most carriers have a minimum premium of $25,000 or more, in Ian’s case he could reduce the premium to $112,500 to create an annuity of $30,000.  Similarly, Ian could elect for payments to start at age 83 or 84 and keep the maximum premium of $125,000.  Since Ian voiced an earlier concern about inflation, he should obtain quotes from those carriers that offer an election to include inflation factors in their QLAC distributions.  Since Ian would depend on long term payout from an insurance company, Fred added, Ian should pay careful attention to the carriers' ratings -- even though state regulators are dedicated to assuring carrier promises are kept to policy beneficiaries.

Before concluding their meeting, Fred told Ian that he wanted to share a recent conversation.  While at his country club, Fred was discussing the merits of the QLAC product with a stockbroker friend.  Fred’s buddy claimed that a QLAC was not necessary – he could create a “synthetic” QLAC by making the right investment choices.  For a minute that seemed possible – but then I asked, what if the choices do not work out?  Will you or your firm guarantee payments for life?  Not surprisingly, my stockbroker friend had no answer.

With that, Fred said, goodnight and happy retirement.  

To see how the strategy outlined above might work for you, try the QLACGuru FailsafeSM Maximize Income Calculator Page.  For more information about QLACs, including Frequently Asked Questions, Articles, and Links to authoritative information about Longevity Annuities, or links to providers Annuity Quotes, please call (800) 460-4166.  



[1] To the extent Ian had one or more IRA, 401(k), 403(b) or 457(b) type of saving plans; he previously consolidated all of these accounts into a single traditional IRA.  Ian did not have nor has a Roth type of savings account.

[2] Original IRA balance of $500,000 – QLAC premium of $125,000 = After QLAC IRA balance of $375,000.

[3] After QLAC IRA balance of $375,000 ÷ number of payment years of 15 = available annual distributions of $25,000.

[4] There are limited options to change the start date of the QLAC payments after a purchase.


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