A Framework for Purchase of Longevity Insurance with Retirement Dollars
On July 1 the Treasury and the Internal Revenue Service issued final regulations for longevity annuities which removed some of the big hurdles in purchasing them with retirement assets. Previously, these contracts – also known as longevity insurance – were not widely utilized in retirement accounts (employer-sponsored and individual alike) due to the required minimum distribution (RMD) requirements. RMD rules mandate that individuals begin taking annual minimum withdrawals from their retirement accounts upon attainment of age 70 ½. This development opens a new opportunity to buy protection from the risk of outliving assets within retirement accounts thus helping individuals get on path to a more secure retirement and ensuring they have a stream of income in advanced years.
What is a Longevity Annuity?
Longevity annuity is a deferred-income annuity which allows an individual to purchase for a lump-sum premium a guaranteed income stream. Annuity payments typically commence when a retiree reaches his/her late 70s or early 80s and continue throughout the annuitant’s life expectancy.
What Did the Regulations Change?
The new regulations changed how required minimum distributions are applied to longevity annuities; specifically, these contracts are no longer required to begin the payout pre-maturely to comply with the RMD rules. Plans and account owners in turn will not be considered out of compliance for delaying distributions from these contracts when operating within the parameters spelled out by the Treasury.
What Are the Key Points of the Final Regulations?
Here are the highlights:
- Distributions from a longevity annuity must commence no later than age 85.
- Participants may use up to the lesser of 25% of their account balance or $125,000, if less, to buy a qualifying longevity annuity. When applying the limit, all IRAs of an individual (except Roth) are considered, but the purchase may be made out of one account. The dollar level is subject to cost-of-living increases in $10,000 increments. An example provided in the regulations illustrates a payout for a 70 year-old individual investing $100,000 in the range of $26,000-$42,000 depending on the actuarial assumptions of the annuity provider and form of annuity selected by the annuitant.
- Longevity annuity may contain a return of premium feature (ROP) which would allow premiums received but not yet paid out to be returned to account holder’s beneficiaries if the annuitant dies before or after the annuity commencement date. This option may be available even if the annuity payment initially continues to the surviving spouse. The ROP payment must be made by the end of the year following the year of death.
- The rule contains a provision that allows individuals who accidentally violate the 25%/$125,000 limit on premium without disqualifying the annuity purchase. The error will need to be fixed by the end of the calendar year following the year in which the limit was exceeded.
- The regulations lay out a format for these contracts called Qualifying Longevity Annuity Contracts (OLAC). Annuity may specify that it is a longevity contract in the insurance certificate, rider, of contract endorsement. Contracts themselves have to be relatively simple (variable, indexed, or similar contracts are not permitted as QLACs) in order to provide a predicable stream of income, not to reduce the income stream due to added costs, and to make it easier to comparison-shop options available in the market place. The regulations provide that the Commissioner may provide an exception to this rule in revenue rulings, notices and other published guidance. Features such as commutation benefit and cash surrender values are also not permitted.
- QLACs may not be purchased with Roth IRA dollars since Roth accounts are not subject to RMDs; if a part of a participant’s account balance is used to purchase a longevity annuity and then that amount is later moved to a Roth IRA, that annuity will cease to be a qualifying longevity annuity after the conversion date.
- QLACs may be purchased with 403(b) account balances and governmental 457(b) plans.
- Annual reporting requirements for QLACs are similar to those applicable to IRA Contribution Information transmitted by the annuity issuer on Form 5498; individual will be required to receive similar information from the issuer by January 31 following the year for which the report is required.
This is not an unexpected development; it further demonstrates commitment of the administration to finding ways of improving retirement experiences and outcomes by offering access to lifetime income options. The Department of Labor spearheaded a similar initiative looking at ways to provide lifetime income options in retirement plans.
Accessibility of retirement dollars for purchase of longevity insurance presents new distribution planning opportunities for retirees who do not wish to use annuities as exclusive means of retirement income but may wish to guarantee a level of income in later retirement years, i.e. possibly more flexibility and predictability. As with any pieces of new guidance, there will be questions and need for clarification on a variety of points. We will continue to monitor this important development and keep you apprised of the industry’s response, commentary from the regulators, and new product announcements.