Does A (Qualified) Longevity Annuity Contract (QLAC) make sense?

On Behalf of | Sep 4, 2015 | Uncategorized

Be careful. This may not make good financial sense for you right now. Michael Kitces explains why.The longevity annuity – also known in some circles as the Deferred
Income Annuity (DIA) – is similar in principle to an immediate annuity,
where a lump sum is converted into a lifetime stream of payments. The
key distinction, however, is that with a longevity annuity, the payments
for life don’t begin immediately. Instead, they start at some point in
the future.
While the Qualified Longevity Annuity Contract (QLAC) rules allowing a
longevity annuity to be owned inside of a retirement account were
essential to avoid running afoul of the RMD rules, the question still
arises: a (qualified) longevity annuity can be now purchased inside of a retirement account… but will anyone actually want to?  Thus far, the industry statistics suggest that demand for the products is still weak. In 2012, longevity annuity purchases topped $1B for the first time (averaging $250M per quarter), and in the first quarter of 2014 they’re up to $620M (an annual pace of almost $2.5B). However, the first quarter of 2014 also saw $57.7B of total annuity sales, which means longevity annuities only make up barely more than 1% of all new annuity transactions. By contrast, even single premium immediate annuity purchases were $2.5B in Q1 of 2014, nearly quadruple the pace of longevity annuities. Nonetheless, interest in longevity annuities does seem to be growing, and more companies are throwing their hats into the ring with new products.  At a more basic level, though, the fundamental challenge is that in a world where consumers are often loath to purchase an immediate annuity – ostensibly out of concern for losing their liquidity and their upside potential – it seems even more of a stretch for a longevity annuity to be compelling, with the same problems but no payments until what may be decades from now. Fortunately, the common “what if I get hit by a bus” fear can be mitigated at least, with the purchase of a return-of-premium death benefit, though such guarantees just lower the payments even further. For instance, the 55-year-old who purchases a longevity annuity for $100,000 will get guaranteed payments of $3,690.30/month starting at age 85 with a return-of-premium death benefit along the way. However, if we calculate the actual internal rate of return being generated on the longevity annuity over the time period, the results turn out to be less compelling, as shown below. Internal Rate of Return (IRR) On Longevity Annuity Starting At Age 85]
As the results reveal, it still takes until age 87 before the couple actually receive back their original principal and begin to generate any actual “return” on their dollars. Even by age 90, the internal rate of return is only 3%, and by age 100 it’s still only 5.3%. While 5.3% certainly isn’t a “bad” return from an annuity company, over a 45-year time horizon it’s still not a very compelling return either, as a combination of both interest rates and mortality credits. Even in today’s low-return environment, long-term corporate bonds pay close to those yields, and the long-term return on equities is highly likely to beat 5.3% over 45 years as well (especially given that no cash flows are assumed for 30 years, which provides a significant barrier to fend off market volatility along the way). In other words, while it might be nice that a longevity annuity can give a significant payment that’s “guaranteed for life” beyond age 85, if it’s internal rate of return is low enough, the truth is that a simple conservative investment over the same time horizon might have generated even more cash flow over any foreseeable age of death (even with very long life). Similarly, the reality is that delaying Social Security – which itself is implicitly a longevity annuity – still has a far better implicit payout rate as well compared to today’s commercial longevity annuities, especially given that Social Security is inflation-adjusted while a longevity annuity also runs the risk that unexpected inflation will significantly degrade the purchasing power of its guaranteed income. (Some contracts do provide inflation-adjusted payments starting after age 85, but still require the retiree to “guess” – and risk being wrong – at what inflation will be between today and when payments begin.) Notwithstanding the not-terribly-compelling implied returns that longevity annuities provide in today’s marketplace, the potential remains for longevity annuities to become an increasingly significant part of the retirement income puzzle, especially if/when/as interest rates rise (boosting future payouts), and/or more companies enter the marketplace (potentially making longevity annuity pricing more competitive – i.e., with higher payouts). And for those who dofind a longevity annuity compelling, for at least a portion of retirement income… the new QLAC regulations do at least permit investors to own such contracts inside their retirement accounts. And while the dollar amount contributions remain limited, from a practical perspective a retiree would likely only put a portion of funds into a longevity annuity anyway (as they still need to fend for themselves between now and when payouts begin!).
In the end, though, whether prospective retirees will pursue such trade-offs or not remains to be seen, and thus far it appears the “breakthrough” of the Qualified Longevity Annuity Contract (QLAC) regulations is more about permitting insurance companies to sell longevity annuities inside of retirement accounts than consumers demanding to do so, especially once guaranteed payouts are converted into the equivalent not-terribly-high return they’re providing over the ultra-long time horizon. Nonetheless, if guaranteed future payouts get higher in the coming years as rates rise and the marketplace heats up, longevity annuities might get a whole lot more interesting. Read about this on Michael Kitces blog at

William Wombacher, your Central Illinois Certified Elder Law Attorney (CELA) and Social Security Disability Specialist. I’ll help you!
Serving Peoria, East Peoria, Peoria Heights, Pekin, Dunlap, Chillicothe, Morton, Washington, Metamora, Canton, Galesburg, Lacon, Henry, Bloomington, Normal and surrounding cites and counties of Peoria, Tazewell, Woodford, Fulton and  Knox Counties in Central Illinois.



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