Members of Generation X believe they will need to save at least $1 million before they can retire. Who can help them save it?
By Linda Koco
New Treasury Department rules published today aim to help to expand access to longevity annuities not only in 401(k)s but also in individual retirement accounts (IRAs). Supporters predict the regulations will ignite a slow but unmistakable chain reaction in the income annuity world.
The rules say that the value of longevity annuities can now be excluded from calculations of required minimum distributions (RMDs). The RMD is the government’s term for withdrawals that qualified retirement plan owners must start taking — and paying taxes on — at age 70.5.
For advisors who work in both marketplaces, this is news worth following. That’s because expanded access is expected to create demand for more advisory services and potentially for sales of longevity annuities.
Longevity annuities are deferred income annuities (DIAs) that start their income stream at the older ages, such as 80 or 85. The government calls the contracts approved for use in tax-qualified retirement plans “qualifying longevity annuity contracts” (QLACs).
The expected chain reaction goes something like this. Because the regulations are final, longevity annuity carriers will start creating QLAC products for this environment. Advisors will then present those products to plan sponsors and customers; plan sponsors will start offering the product as an income option in their employee retirement plans; and plan participants will start purchasing the long-term guaranteed income streams the QLACs create.
DIA expert Curtis V. Cloke said the advantage for consumers is “they will not have to pay the RMD on the QLAC premium (which can be no more than 25 percent of a person’s qualified account balance, up to a $125,000 maximum).
In addition, “when owners do start taking income from their QLAC, the payments will not be subject to the RMD — because the product has already solved for the RMD from that source of funds,” said the founder and chief executive officer of Thrive Income Distribution System, Burlington, Iowa.
Retirement experts view the longevity annuity itself as a positive for consumers in another way too: The future income stream will be substantially bigger than, say, an income stream from a comparable single premium income annuity purchased on the same day with the same amount but that starts payout in policy year one.
The regulations point to what the income in old age might look like. The example given is of a policy purchased with a $100,000 premium at age 70. At age 85, that policy could provide an income that, depending on assumptions used, pays anywhere from $26,000 to $42,000 a year, the regulations state.
Given that the longevity annuity regulations are now final, DIA carriers will probably start rolling out contracts that meet the QLAC requirements, Cloke predicted.
Most DIA carriers do sell policies on a qualified and non-qualified basis, he said, but he knows of only two that currently allow the income for qualified products to start beyond age 70.5. “There is opportunity here that carriers will understand,” he predicted, so advisors should expect to see more product activity sooner rather than later.
No variable or index annuities allowed
The coming product activity will be in contracts having a traditional fixed annuity chassis. That’s because the rules specifically prohibit use of variable annuities and indexed annuities. The 49-page regulation says that “a contract should be eligible for QLAC treatment only if the income under the contract is primarily derived from contractual guarantees.”
The regulators rule out variable annuities and indexed contracts because, they say, these products “provide a substantially unpredictable level of income to the employee” which is “inconsistent with the purpose of this regulation.”
It’s easy to imagine any number of variable and indexed annuity professionals taking issue with that statement, but it’s the government’s position all the same.
The regulation notes that a number of commenters did ask the government to include variable and indexed products in the QLAC definition. Reasons given were that a narrow definition may limit the demand for QLACs, and that annuities with equity exposure are “better able to address the long-term risk of inflation than fixed annuities.”
However, the regulators said variable and indexed products are out, even if the contracts have a minimum guaranteed income feature.
Cloke believes the government is on the right track with this limitation. Chances are that the variable and indexed annuity contracts would need to add a lifetime income rider and a benefit rollup to achieve the guaranteed income goal, he said. However, based on nationwide mathematical testing that he has performed, “those features add a fee drag that can limit performance. This increases the risk that clients will receive a smaller income than a DIA could provide.”
For that reason, he said, “I support the position that only fixed products should prevail in this market.”
In what will surely be the subject of much annuity industry jawboning, the regulation’s discussion of permissible types of annuities also provided for the possibility of an exception. The IRS commissioner may, the regulations say, “provide an exception to this rule in revenue rulings, notices, or other guidance published in the Internal Revenue Bulletin.”
The regulation has many other product-related provisos and requirements, including these two:
• Carriers may offer a return of premium (ROP) feature that is payable before and after the employee’s annuity starting date.
• Carriers may not offer QLACs having any commutation benefit, cash surrender value or other similar feature, because “availability of such a feature would significantly reduce the benefit of mortality pooling under the contracts.”
Wait and see
Advisors won’t need to get their ducks in a row on QLACs just yet, according to Ken DeFrancesca, managing director for annuities at Incapital, a Chicago investment firm.
It will take some time for industry providers to develop products for sale in this market, he explained. “For now, it’s wait-and-see.”
However, advisors may find excellent client education opportunities as clients call to learn about what Treasury’s longevity annuity regulations may mean for them, he said. In one scenario he envisions, banks might start informing IRA clients about the new regulations and “then invite them to come in and talk to one of our advisors about it.” From a sales perspective, “that’s a great point of conversation.”
Looking ahead, DeFrancesca said it is conceivable that, when employers start adding QLACs to their retirement plans, this will introduce a new form of competition for advisors. Clients may lose interest in buying retail income products if they already have a guaranteed income plan “from work,” he explained.
But that probably won’t happen until younger workers learn about QLACs and start buying them, he added. In fact, in his view, the new regulations are really aimed at helping younger people save for retirement in their employer-sponsored plans.
For now, the market as seen by advisors remains pretty much as it was the day before Treasury announced the regulations, DeFrancesca said. Advisors already roll qualified plan assets into qualified annuities (in IRA wrappers) with guaranteed lifetime income features, he said, and people still need to sit down with the advisor, who explains the options and provides the products.
Linda Koco, MBA, is a contributing editor to AnnuityNews, specializing in life insurance, annuities and income planning. Linda may be reached at firstname.lastname@example.org.
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