QLACs are changing Social Security timing game

Qualified longevity annuity contracts have, in theory, existed for nearly three years, but it’s only in recent months that insurance carriers have begun to offer these products — finally making the QLAC a realistic planning option.

While the purpose behind the QLAC is relatively simple — providing income guarantees late in a client’s life — in reality, this new planning vehicle can reshape the client’s entire retirement income planning strategy.

QLACs won’t replace Social Security as the primary source of retirement income for many clients but, for the higher income client, the introduction of QLACs into the planning mix can drastically alter even the most basic Social Security strategies, including the typical plan for maximizing retirement income by delaying benefits.

QLACs and Social Security: the basics

A QLAC is an annuity contract that is purchased within a traditional retirement plan, under which the annuity payments are deferred until the client reaches old age (they must begin by the month following the month in which the client reaches age 85) in order to provide retirement income security late in life. 

If your clients aren’t asking these questions yet, they will be very soon.

The value of the QLAC is excluded from the retirement account value when calculating the client’s required minimum distributions once the client reaches age 70 ½, though the client is limited to purchasing a QLAC with an annuity premium value equal to the lesser of 25 percent of the account value or $125,000.   

As most clients know, waiting past the normal retirement age to begin collecting Social Security allows the client to earn delayed retirement credits, which increase the eventual benefit by 8 percent for each year in which benefits are suspended. Because of this special treatment, most advisors counsel clients to delay claiming benefits for as long as possible in order to ensure the maximum monthly benefit level.

QLACs and Social Security timing

The introduction of QLACs can now allow clients who have saved for retirement to avoid delaying Social Security benefits entirely — and, because of volatility in the Social Security system and the uncertainty of a client’s lifespan generally, many clients are receptive to this idea because they are reluctant to defer in the first place. 

For most clients, delaying Social Security benefits past retirement age means that withdrawals from tax-preferred accounts must increase during the deferral period in order to ensure sufficient income while maximizing the benefit level for a later time. However, this means that tax-preferred accounts are depleted at a much more rapid rate early in the client’s retirement — leaving a lower account value to grow over subsequent years.

By purchasing a QLAC within the retirement account, the client can reduce his or her account distributions and eliminate the associated income tax liability, yet still secure a higher level of guaranteed income to supplement Social Security later in retirement.

If the client claims Social Security benefits early in retirement, the amount that must be withdrawn from tax-preferred accounts is reduced and a larger portion of his or her retirement savings can be left intact to grow — generating a higher account balance in the long run. 

With the QLAC, the client still has a guaranteed source of income late in life — regardless of poor market performance or unforeseen circumstances — to supplement the lower Social Security benefit level that reduced the need for high withdrawals early in retirement.

Conclusion

The introduction of QLACs can change the traditional rules of retirement income planning dramatically — making it important that advisors re-evaluate current strategies in order to give clients the opportunity to incorporate these products into the retirement income planning playbook.