Personal Finance

Lawmakers want to make it easier to have guaranteed income in retirement

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Key Points
  • Pending legislation would eliminate the 25% cap on how much of your retirement savings you can put in a qualified longevity annuity contract, or QLAC.
  • Roughly 3 in 4 retirees and workers say income stability ranks above preserving account balances or maintaining wealth, according to 2020 research.
  • It's important to understand the risks of a QLAC, as well as how it fits into your overall financial plan.
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One type of annuity may be poised to get a bit of a makeover.

Under bipartisan retirement legislation pending in both the House and Senate, the rules applying to qualified longevity annuity contracts, or QLACs, would be changed. Although the two chambers' provisions differ somewhat, both would remove the 25% cap on how much of your retirement savings you can put in these insurance options, as well as let buyers have a 90-day free-look period.

In simple terms, QLACs are contracts that involve paying a lump-sum premium from your retirement account — i.e., 401(k) or individual retirement account — to an insurance company and then receiving a guaranteed monthly amount, for the rest of your life, starting at a predetermined point in the future.

QLACs, like other guaranteed-income options, address the concern that many individuals have about outliving their savings. Roughly 3 in 4 retirees and workers say income stability ranks above preserving account balances or maintaining wealth, according to 2020 research from the Employee Benefit Research Institute.

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Generally, the longer the deferral period with a QLAC, the higher the payments. However, you must start the income stream by age 85.

"If you're really focused on … longevity, insurance and the risk of outliving your money, this is just one tool available," said certified financial planner Rob Greenman, chief growth officer for Vista Capital Partners in Portland, Oregon. 

"You have to make sure it's the right fit for your financial plan and works in concert with everything else you're doing," Greenman said.

In addition to the 25% cap currently in place for how much of your retirement money you can use to buy a QLAC, it cannot exceed $135,000 (2021 limit). The Senate version of the retirement legislation would raise that to $200,000.

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Additionally, the money used for the QLAC is excluded from required minimum distribution calculations until you begin getting the income. (RMDs are amounts you must take from most retirement accounts starting at age 72.)

QLACs can be set up as joint annuities. This would mean the payments continue as long as you or your spouse are alive.

However, QLACs are not without risk. For one, if there is no cash refund feature — which basically means paying a beneficiary a lump sum of what's left of your premium, if anything —  payments stop once you die.

A male who buys a QLAC for $135,000 at age 70 would get $26,656 yearly starting at age 85, according to an online calculator from Fidelity Investments. For a female, the annual payout would be $24,034 (women tend to live longer).

In those scenarios, a man living to age 90 would get $133,280 — just under his initial investment. On the other hand, if he were to live until age 95, he'd get $266,560 over that 10 years of payouts.

"But it's really just a bet," Greenman said. "If you live a long time past 85 … you win because the annuity company has to pay that out for the rest of your life."

However, if you are wrong and die soon, you are out the money you put into the annuity. "That's where you lose," Greenman said.

It's uncertain when the bills that include the QLAC changes — as well as a host of other provisions that aim to improve retirement savings — will move forward in the legislative process.