[Narrator] David, Bill, and Allen are lifelong friends. The three met at a recent gathering. Each was 65 years of age. So, the topic came up of how they were going to manage their retirement funds. All three men had managed to save about $400,000 and the savings were in their respective IRAs.
About to retire, David was evaluating the purchase of an immediate annuity with his IRA funds. The immediate annuity would provide monthly annuity payments for the rest of David's life in exchange for his $400,000 premium. David particularly liked that the payments would continue for life, no matter how long he lives.
Bill, on the other hand, said he was going to keep his money in an IRA and allow it to grow, withdrawing money as required by the IRS Required Minimum Distribution (RMD) rules. While admitting the RMD distributions will change with age and market gains and losses in the IRA, he feels confident that he can manage the volatility of his strategy to create the best possible outcome. Bill also pointed out that he Is continuing to work and will not need the IRA funds until someday in the future.
Allen told the group he was interested in a new type of annuity, a Qualified Longevity Annuity Contract (QLAC). Under IRS regulations issued July 2014, Allen could invest up to 1/4 of his $400,000 in a QLAC. The $100,000 premium, he explained, would not be counted in the calculation of the IRA Required Minimum Distribution (RMD) beginning at age 70. Also, the QLAC life annuity start date could begin as late as age 85. In this way, the QLAC could provide certainty and cash flows in Allen's later retirement, no matter how his IRA assets perform in the future. Like Bill, Allen still worked, and Allen appreciated how the QLAC reduced RMDs and pushed retirement income into the future.
Always competitive, the three friends argued about whose solution was the best. Finally, the group agreed to invite a mutual friend, Ned, a fee-based certified financial planner, to look at the three options and tell them which solution might be the best.
[Ned] The easiest way to think about these three retirement options is in terms of risk. A traditional IRA and Immediate Annuity stand at opposite ends of the risk spectrum. While the combined QLAC-IRA investment lies somewhere in the middle.
Let me explain. An IRA has Market Risk, the risk that the value of your investments will go up and down with changes in the market. Market Risk can be potentially high in times of high market volatility or declining interest rates.
On the other end of the spectrum, the immediate annuity has Policy Issuer Risk. Policy Issuer Risk is the risk that the insurance company for some reason can no longer make annuity payments.
Both Market Risk and Issuer Risk can be managed. For example, the IRA's Market Risk can be managed by buying Bonds instead of Stocks. The Policy Issuer Risk of an intermediate annuity can be reduced by selecting a highly rated insurance carrier. Trade-offs also exists between the immediate annuity and the IRA in terms of potential returns. The IRA offers a higher potential upside, but also a downside. While the immediate annuity is likely to offer lower, but very predictable income year-in, year-out.
With IRA's invested in fixed-income securities, retirement planners like to apply the old 4% rule of thumb whereby investors withdraw 4% each year over their retirement years. The assets will hopefully last through retirement.
But be careful. 'Hopefully' is the key word here. The 4% Rule was developed in the nineties when returns on assets were much higher. The 4% approach can be problematic for some, especially those with fewer assets. Also, many people have trouble staying by their decision to spend only 4% yearly in retirement. For example, they may overspend early on travel and retirement bucket lists. This can put them in trouble in their later retirement years. Most important of all, today's much longer lifespans are putting retirees at risk of outliving their assets. The IRA-only approach means Investors are literally self-insuring for their own longevity risk.
Now for the QLAC option. QLAC annuity products are specifically designed to manage the risk of outliving one's assets. Purchasers can make an investment and defer the annuity's payments as late as their 85th birthday. The assets used to buy the QLAC fall outside the IRA and therefore, reduce the Required Minimum Distributions -- and taxable income.
The QLAC versus the immediate annuity and IRA-only approach boils down to two key points. Required IRA distributions are deferred compared to either an IRA-alone or an immediate annuity approach. The ability to defer distributions without tax means deferral of taxation. The IRA-QLAC combination moves the risk needle of the owner to the middle: somewhere between the IRA alone and the immediate annuity. The QLAC allows a portion of the assets to generate fixed income for life. The remainder continue to perform with the upside -- and downside -- of a conventional IRA.
To find the best answer for any person, that person must evaluate their own risk preferences. They need to think about their near and long-term income needs. They need to make a realistic appraisal of their health and likely longevity. And they need to look at their tax situation and think about their own budgeting behavior. So, each of the 3 alternatives can be the best choice.
Pro's and Con's
Here's a quick review of the pros and cons of the 3 approaches.
IRA: Pro - most flexibility in a strong market. Outperforms other alternatives. Easy to see and understand. Best chance of creating an estate in death beneficiaries. Con -- in a weak market, underperforms other alternatives. Tends to move taxable distribution events up front. Investor self-insures for the risk of outliving their own assets.
Immediate Annuities: Pro -- No exposure to weak markets. No RMD computations required. Fixed lifetime payments are worry-free. Con -- no investment benefit from strong markets. No residual assets for an estate. No ability to push benefits into later retirement years. Income taxes are accelerated into earlier retirement years rather than later ones. An immediate annuity is an insurance contract -- not FDIC insured. All risk resides in the annuity carrier's ability to perform.
IRA with a QLAC. The Pro -- a QLAC provides significantly more old age guarantees.75% of assets not invested in a QLAC will enjoy upside of strong markets. Any estate assets will be slightly less than just an IRA. The QLAC provides and appealing mix of secure income and market exposure. QLAC purchase is not taxable, and it reduces IRA assets for RMD calculation. Income taxes are deferred by both the QLAC and the IRA. Con -- QLAC purchase cannot be revoked. A QLAC is an insurance contract -- not FDIC insured. Exposes 75% of IRA assets to weak market vacillations.
[Narrator] After hearing Ned's presentation, all three investors decided to go through Ned's checklist and meet with him individually to go over their retirement plans.
If you would like to learn more about retirement annuity options, including both QLACs, and immediate annuities, please call 800-460-4166 or visit www.QLACguru.com. Thanks for listening.
Notice: The foregoing video and examples do not portray any one person’s situation. The dramatizations were prepared by the Company to introduce viewers to a new financial product, a Qualified Longevity Annuity Contract. Individual circumstances of a viewer are likely to vary from the examples in the videos. The videos are not tax or legal advice. The financial information, and calculations depicted in these videos are supplied from sources we believe to be reliable. However, we are unable to guarantee their accuracy. These materials are not intended to replace the viewer’s legal, tax and accounting advisors. Any viewer should seek advice from his or her qualified advisors prior to entering into a QLAC purchase. The Company accepts no responsibility for any outcome arising from a QLAC purchase or a failure to make a QLAC purchase. This material is not intended to be used, nor can it be used by any taxpayer, for the purpose of avoiding U.S. federal, state, or local tax penalties.