Longevity Annuities in Retirement Plans — Much Ado About Nothing?
A longevity annuity contract (LAC) is an annuity that begins payments at an advanced age, that is often decades after the annuity is purchased (for example, an annuity that is purchased at age 65, but where payments do not commence until a participant turns 85). This is quite different than the more typical type of retirement plan annuitization option, which is a single-premium deferred annuity, where an account balance or portion thereof is used to provide a stream of income payments that commences immediately. I have rarely seen such contracts — which is why the plan sponsor and participants with whom I work are likely to ask the aforementioned question.
One reason for the rarity of such annuity contracts is the minimum distribution requirements under Code Section 401(a)(9). If I purchase an annuity that commences payments at age 85, and I retire before that age, I must commence minimum distributions from an annuity contact which, unfortunately, prohibits such distributions before age 85. Thus, I am unable to satisfy the minimum distribution requirements from later of age 70½ or retirement until age 85, incurring the draconian IRS penalty of 50% of the amount that is not withdrawn each year. Needless to say, this is not a pleasant outcome!
However, the final regulations address this issue by creating a Qualified Longevity Annuity Contract (QLAC), where an annuity will not be subject to the normal penalties for a missed required minimum distribution (RMD), if the following requirements are met:
- No more than 25% of a participant’s account balance or $125,000, whichever is less is used to purchase the QLAC;
- Payments must commence no later than the month following the participant’s 85th birthday;
- The annuity does not contain any cash surrender value or allow commutation (cessation of the annuity and distribution of the remaining values from the contract);
- The annuity is not a variable or equity-indexed annuity (i.e. payments must be fixed); and
- The annuity only permits certain types of death benefits, as described in the regulations.
Thus, it will now be more practical to provide longevity annuity contracts in retirement plans, and I can imagine that we can expect product providers to market such benefits to retirement plan sponsors.
Will Participants Purchase QLACs?
- Practice Pointer: Explaining a longevity annuity to plan participants, or even plan sponsors, may be the retirement plan equivalent of rocket science. Thus, using simple terms, and explaining the basics of what an annuity is designed to do in the first place, should be a good place to start.
Though some commentators seem to believe that QLACs will take the world of retirement plans by storm, especially when the Department of Labor finalizes participant statement requirements for lifetime retirement income projections, I, for one, find that much of an increase in QLAC usage difficult to fathom. QLACs clearly would be a viable option for someone who has limited need for immediate retirement income and wishes to preserve retirement plan assets, or for someone who simply wishes to lock in an income payment stream at later ages that would be far greater that normally be possible under conventional annuity options (due to the time value of money and increased mortality factors); however, the vast majority of participants have enough difficulty accumulating sufficient retirement income in the first place, never mind enjoying the luxury of having so much retirement income that they can postpone payment of a portion of their benefit for many years.
Secondly, in my experience very few participants actually annuitize. The vast majority of participants take lump-sum distributions, partial payments, or withdraw funds as needed. Thus, if annuitization options that provided for immediate income are far from popular, why does anyone believe that annuities that provide for delayed payment will be prevalent?
Finally, the concept of annuitization is far too complicated for many participants to grasp. Studies have shown that most plan participants have little retirement plan literacy even regarding the basics. And annuities are FAR from a basic concept; I try to explain to participants that an annuity is basically a retirement plan version of the Social Security income they receive, but even then, their eyes begin to glaze over...
And for the few participants who do grasp annuity concepts, they are often confused between annuity investment options and the actual annuitization of their retirement plan benefit. Throw in the unique complexities of longevity annuities, and it all adds to a scenario that does not suggest rampant utilization.
Though it is encouraging that, thanks to the IRS, longevity annuity options will now be viable, it is difficult to envision long lines of participants waiting to be among the first to purchase such products. Of course, until such products are widely available in retirement plans, utilization remains a matter of speculation, though the lackluster history of utilization of retirement plan annuitization options in general can serve as a guide.
Michael Webb is a Vice President at Cammack Retirement.
- Practice Pointer: As the IRS and DOL move forward with their joint initiative to promote lifetime retirement income, it might benefit advisors in their plan sponsor relationships to become a scholar of annuitization and other retirement income issues, even though actual utilization of products such as longevity annuities may remain low.
Opinions expressed are those of the author, and do not necessarily reflect the views of ASPPA, or its members.