Retirement Savings Bills Would Boost Deferred Annuities

When Congress returns for a short post-election session, one item on its to-do list is major retirement savings legislation that has broad bipartisan support. One feature of both House and Senate bills: Expanding a deferred annuity called a Qualified Longevity Annuity Contract (QLAC).

Both bills would increase the allowable size of QLACs. That might make them more attractive to some middle- and upper-middle income retirees. But Congress faces a balancing act: It wants to jump-start a product that financial economists love but consumers don’t. And it needs to do so without turning QLACs into another tax shelter for the wealthy.

Steady monthly payments

Like any fixed annuity, QLACs pay a steady monthly income, but their payments are deferred until you are at least age 75. That deferral means you can buy a QLAC for a much lower initial investment than immediate annuities, making them more accessible to middle-income retirees.

For example, a 72 year-old who buys a plain-vanilla $135,000 QLAC, with no cash refund and no inflation protection, would get a monthly payment of about $2,200 starting at age 80. An immediate fixed annuity pays out less than half that each month.

And QLACs carry an extra benefit: Those age 72 or older who must take Required Minimum Distributions (RMDs) from their IRAs and 401(k)-type retirement plans can lower their taxable distributions by purchasing a QLAC. If you buy with pre-tax retirement assets, you’ll still have to pay tax on QLAC distributions but not until the annuities begin paying out years in the future.

QLACs and Long-term care insurance

In theory, these products could be something of a substitute for long-term care insurance. They’d pay a steady monthly income for life starting, say, at age 80, about the time when many people begin to need personal assistance.

They may also be less expensive and less complicated than so-called combo or hybrid products that pair long-term care insurance with annuities or whole life insurance.

Unlike long-term care insurance, there is no medical underwriting when you buy and no claims process. You turn reach your payout age and get the cash. The downsides: QLACs won’t help fund care before you reach your payout age. And unlike a whole life/long-term care product, there is no death benefit.

Ideally, your retirement income should finance both routine expenses and any unexpected costs. If you already have enough to manage those day-to-day expenses, a QLAC could generate additional steady monthly income at a time when you are likely to have higher medical or long-term care expenses.

Cutting some strings

But QLACs come with strings that limit their utility. The big one: You can invest no more than $135,000 or 25% of your total retirement account balance over your lifetime.

That could help fill in an income gap for someone who requires long-term care. But it would fall well short of what they’d likely need to pay for a nursing home or assisted living, or even extensive home care.

According to Genworth’s cost of care study, the median monthly cost of a private room in a nursing home is $9,000, the cost of an assisted living facility is $4,500, and a home health aide can cost between $2,500 and $5,000, depending on the number of hours you need. Far more than today’s QLAC will throw off.

Now, Congress may change that.

A bipartisan bill drafted by the Senate Finance Committee, called the Enhancing American Retirement Now (EARN) Act, would raise the maximum investment to $200,000 (indexed for inflation) and eliminate the 25 percent threshold.

The House bill, called Securing A Strong Retirement Act, or SECURE 2.0, would repeal the 25 percent limit. That measure passed the House with broad bipartisan support last Spring.

“These make the most sense for somebody in good health, with money in their IRA they don’t need to live on, and who don’t want to make their RMDs,” says Tom West, a wealth manager in Tysons Corner, Virginia.

Balancing interests

As currently designed, QLACs fall between the cracks. For wealthy retirees, they are too small to generate meaningful monthly payments or up-front tax savings. For middle-income people, they can’t fill enough of the gap between other retirement income and long-term care or medical costs in old age.

Are the benefits enough to lock up $100,000 for years? Are people willing to forego a return if they die before the annuities begin to pay out?

Today, relatively few consumers think so. If interest rates keep rising and the stock market continues to sag, fixed annuities may have a moment. But QLACs will need to get bigger before they attract much attention.

That means Congress must balance those two competing interests. If it wants to build a market for QLACs, as it seems to, it will need to raise the cap on maximum investments made out of retirement funds. But it also needs to avoid turning QLACs into yet another way for the very wealthy to avoid RMDs.