Worried you'll outlive assets? Consider a longevity annuity

Qualifying Longevity Annuity Contracts may sound complicated, but the idea behind them is fairly simple.

"A longevity annuity is like buying a pension that does not begin until old age," said lawyer and certified financial planner Frank Napolitano, a senior financial advisor with Sensible Financial Planning. "They are a hedge against outliving your assets."

"Think about them as insurance, not as an investment," he added. "By deferring payments until later, as with Social Security, you'll have a greater lifetime benefit — if you live a long time."

To be considered "qualifying," these contracts must satisfy certain IRS requirements, introduced in July 2014:

1. The value of a QLAC must be excluded from the account balance used to determine required minimum distributions.
2. Distributions must begin by age 85.
3. Participants may use up to 25 percent of their account balances, or $125,000, whichever is less.

QLACs are purchased via a lump-sum payment and are thus removed, without penalty, from the retirement account. This, however, reduces the amount in the account, resulting in lower future payouts (of required minimum distributions).

"I think QLACs are the ultimate catch-22 product," said Chris Chen, CFP and wealth strategist with Insight Financial Strategists. "In my opinion, the issue about reducing RMDs [is] noise to the fundamental question: Either you need QLACs and cannot afford it, or you can afford it and you don't need it.

"Say you have a client with a $500,000 IRA, with nothing else," he explained. "If you project that, it will fund them up to age 85; the client needs a QLAC at 85 but cannot afford to carve away any funds."

In order to purchase a QLAC, this client would have to find a way to free up money to purchase the contract.

"Say you project that this client needs only $300,000 until age 85," Chen continued. "Your client can afford a QLAC but may not need it, because the remaining $200,000 may be deployed in other ways."

Scott Witt, a fee-only insurance advisor and owner of Witt Actuarial Services, said he doesn't "necessarily agree with the catch-22 idea."

"It's a great tool for the advisor to have because it gives you a finite period to plan for," he said. "By using a QLAC, you have taken care of income needs post-age 85, and this allows you to free up the rest of the client's portfolio for investment, liquidity and legacy planning."

By using this particular type of longevity annuity, you have eliminated one unknowable variable — the date of death, Witt said.

How does one know when to purchase a QLAC?

"It's a combination of art and science," Ross said, suggesting the time to consider this strategy is between ages 55 and 70.

"In its basic form, there is no inflation protection," said Witt of a QLAC. "There is usually an inflation rider available, but it may not begin until payout. A rider will also lower initial monthly payouts."

An extended waiting time can also be an issue, Witt said. "The longer you wait to begin payouts, there will be exponential growth in monthly payments."

According to Eric Ross, CFP, a financial planning specialist with Truepoint Wealth Counsel, "a fixed annuity is one way to control volatility risk."

"You're transferring risk from the market to the insurance company and trading a volatile asset class for a reliable asset," he added. "But if you have a sufficiently long time horizon, a balanced portfolio will serve you better in building wealth."

Marcio Silveira, CFP and founder of Pavlov Financial Planning, said there is a more subtle problem that may affect many NAPFA-registered advisors.

When a longevity annuity is purchased, there is less money to be invested in the advisor-managed portfolio," Silveira said. "So this means [fewer] assets-under-management fees for the fee-only advisor.

"In this case, it is the lack of commissions that creates a conflict of interest to the detriment of the client."

Witt at Witt Actuarial Services highlights a potentially profound benefit to the client. "The emotional and math dynamic changes dramatically if you know that your liquid assets only have to make it to a certain age," he said.

— By Deborah Nason, special to CNBC.com