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Retirement Perspectives

Why older investors are deferring withdrawals by purchasing a qualifying longevity annuity contract (QLAC) within their IRAs or 401(k)s. Here's how.

Worried about outliving your retirement savings as life expectancies continue to increase? You’re not alone. A whopping 61% of Americans fear running out of money more than they fear death, according to an Allianz study, and a recent defined contribution (DC) plan participant survey by Cerulli Associates participants age 45 and older were “generally clueless” about retirement income planning. As Cerulli director Jessica Sclafani put it, fully one-quarter of respondents explicitly answered, “I don’t know what I will do with my 401(k) account savings.” And another one-quarter say they will ask their existing financial advisors for advice.   

Are Longevity Annuities Right For You?
In recent years, there has much discussion about the potential role of longevity annuities as part of a retirement income strategy. What complicated matters, though, is that retirement account owners generally have to take required minimum distributions (RMDs) once they turn 70½. And if a longevity annuity is purchased inside of a retirement account (e.g., 401(k) or IRA), it may not satisfy the myriad of RMD rules, which were created in part to prevent retirement investors from deferring income taxes forever.  

How a QLAC Deferred Annuity May Provide Greater Flexibility
In 2014, the IRS issued regulations that would a permit a portion of retirement accounts to be invested in a qualifying longevity annuity contract (QLAC) without running afoul of the RMD rules. This is a deferred annuity that an individual can purchase with a limited amount of his or her IRA or employer plan funds. The amount of the annuity is not counted in the RMD calculation until the individual reaches his or her annuity start date, which is the month after the individual attains age 85.

A retiree can invest up to 25% of his/her retirement account balances (up to a maximum of $130,000) into a QLAC, while the annuity payments can begin as late as age 85. Notably, the other 75% of retirement accounts (excluding Roth IRAs, which are not subject to lifetime RMDs) must still take RMDs.

For example, if the value of your retirement account is $520,000 and you purchase a QLAC for $130,000 your required minimum distribution will be calculated on $390,000.

These rules may provide an individual with greater flexibility for a portion of his or her pretax assets, allowing the individual to delay taking income payments until he or she needs them. RMDs can be postponed beyond age 70½ by purchasing a QLAC, while still locking in guaranteed income in the future. This strategy would reduce RMDs, while an individual would likely pay less in taxes. In other words, the taxable portion of the money used to purchase the annuity will still be subject to taxes upon receiving income, which could be as late as your mid-eighties.

Death Benefits
A QLAC can provide a return-of-premium death benefit that would return to the account any premiums paid—less any income payments—when the annuity purchaser dies.

How Do You Know If a QLAC Makes Sense?
QLACs, however, are not for everyone. So, ask yourself the following questions: How is my overall health?  Can I live comfortably by deferring income? Do I want retirement income for life? Could I outlive my retirement nest egg?

What Else Do I Need to Know about QLACs?

  • The final QLAC regulations also allow a participant in a 401(k), 403(b), or governmental 457(b) to use a portion of the account to purchase a QLAC.
  • The QLAC must be purchased from an insurance company. The contract must state that it is intended to be a QLAC.
  • To qualify as a QLAC, the annuity contract must also provide that annuity payouts will begin no later than the first day of the month following the month in which the taxpayer reaches age 85. 
  • The contract cannot contain any features that would provide for commuted benefits (lump-sum distribution) or cash surrender rights.
  • Death benefits must meet specific requirements, depending on various factors, such as whether the beneficiary is a spouse, when the participant dies, etc.
  • The annuity cannot be a variable annuity or equity indexed contract; however, it can be an increasing annuity that provides for cost-of-living increases.
  • QLAC cannot offer the insured the option to cash out the benefit or accelerate payments.
  • Company plans (e.g., 401k) are not required to offer the option to purchase a QLAC.
  • An annuity purchased within a Roth IRA cannot qualify as a QLAC.
  • An excess amount used to purchase a qualifying longevity annuity contract (QLAC) will disqualify the QLAC unless it is timely returned to the IRA.

 

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

GLOSSARY OF TERMS

Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.

A SIMPLE IRA plan is an IRA-based plan that gives small-business employers a simplified method to make contributions toward their employees’ retirement and their own retirement. Under a SIMPLE IRA plan, employees may choose to make salary reduction contributions and the employer makes matching or nonelective contributions. All contributions are made directly to an individual retirement account (IRA) set up for each employee (a SIMPLE IRA). SIMPLE IRA plans are maintained on a calendar-year basis.

A simplified employee pension plan (SEP IRA) is a retirement plan specifically designed for self-employed people and small-business owners. When establishing a SEP-IRA plan for your business, you and any eligible employees establish your own separate SEP-IRA; employer contributions are then made into each eligible employee’s SEP IRA.

Qualified Retirement Plan—This is a savings plan that is allowed certain tax advantages because it meets criteria spelled out in the IRS Code and in the Employee Retirement Income Security Act [ERISA] of 1974. Employers can take tax deductions for any contributions they make to an employee's account. Employee contributions and investment returns are tax-deferred until withdrawn. Contribution limits apply, as do penalties for early withdrawal.

401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on an aftertax and/or pretax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.

Required minimum distribution (RMD) is the minimum amount you must withdraw from your account each year. You generally have to start taking withdrawals from your IRA, SEP IRA, SIMPLE IRA, or retirement plan account when you reach age 70½. Roth IRAs do not require withdrawals until after the death of the owner.

An IRA rollover may involve the application of fees and charges to the investor. A rollover is the process of moving your retirement savings from your retirement plan at work (401(k), profit-sharing plan, etc.) into an Individual Retirement Account (IRA). 

The Summary Plan Description (SPD) issued by plan administrators explains participants’ and beneficiaries’ rights, benefits, and responsibilities under the plan in understandable language. The SPD includes such information as: the plan’s requirements regarding eligibility; a description of benefits and when participants have a right to those benefits; procedures regarding claims for benefits and remedies for disputing denied claims; and the rights available to plan participants under the Employee Retirement Income Security Act (ERISA).

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