Qualified Longevity Annuity Contract - QLAC

I’m going to buy a single-life, life-only Qualified Longevity Annuity Contract (QLAC) from Fidelity. I am trying to solve a few problems… my IRA is large, and despite my best efforts to use it early, I may be choking on money at RMD time, because I’ll likely be a single-filer (my wife has serious health issues), which could boost me into bad Medicare Part B IRMAA surcharge brackets (think hundreds of $$$ more per month), and higher income tax brackets.

The quote is for a single-life, life-only QLAC for a 62 yo male with MassMutual.

If I spend $200,000 out of my IRA now at age 62, with no current year tax impact, then from age 85 until death I get $132,796 per year. Now… $132,796 in 23 years might only be worth $67,000 in 2023 Dollar terms, but still… it would pay itself back, adjusted for inflation, in 3 years. So if I live past my 87th birthday, I gamed the insurance company. My Dad lived to 89, and his health at 62 was way worse than mine is now.

The QLAC raises my retirement score on Fidelity’s retirement tool and Flexible Retirement Planner (by Random Walk Ventures LLC), and counterintuitively raises the ending account value for my heirs.

It solves the RMD problem partially, plugs the inflation gap in my Long Term Care plan, and improves the retirement plan overall by reducing portfolio variance (fewer Monte Carlo simulations fail). I also cannot outlive the annuity.

Finance geek notes:

The nominal internal rate of return (IRR) is 7%, assuming I live to 95, which is the end of my plan. So, where can you get something almost as risk-free as a US Treasury Bond which matures in 23 years yielding 7%… which is tax-deferred? You can’t. 20 year USTs pay 4.1%.

Pre-emptive push-back on the doubters… “BUT WITH VTI or VOO you can expect 10% long term!” No, you cannot compare an almost risk-free claim on future cash flows against a sordidly volatile investment like a 100% equity fund. The risk-free rate is the y-axis intercept of the Efficient Frontier horizon line in Modern Portfolio Theory (MPT). If you find me a stock portfolio that lies along that upwardly-sloping-to-the-right line with zero risk pegged at 7%, yes, I will buy that one from you. But they don’t exist. Bernie Madoff offered such an investment in the past, I believe. Enron, too.

TL;dr a QLAC adds a stream of cash flows which is not correlated with other components of my portfolio; the stocks, the bonds, the real assets. That non-correlation makes the whole portfolio work better. And it does so when there is a risk of running the other assets down, or towards end-of-life when long-term care needs can cause an explosive need for cash.

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I like having RMDs.

They give me lots of flexibility for paying taxes and making QCDs.

The problem with RMDs is, now that the RMD age (for people my age) will be 75 eventually, people are going to defer, defer, defer and then it’ll blow up like an M-80 in their faces. I was thinking about QCDs, too. Like if I have too much IRA money, and this $132,796 annuity kicks in at 85 on top of it and does bad things to me… just QCD-away enough money to get rid of the MAGI / IRMAA problem and benefit a charity at the same time.

Thanks for your thoughtful post. I presume you have considered Roth conversions before age 75 and decided they aren’t appropriate for your situation or don’t go far enough in reducing the problems of RMDs.

Roth conversion would work fine, but I’m probably going to be a single-filer before age 75, which will cut back by about 50% on what I can do without causing Maggie and Irma havoc. But now that I found that QLACs actually help the portfolio perform without even considering the tax and Medicare benefits, hey, why not? Sign me up.

I wouldn’t do it, here’s why:
If you’re 62 now and you’re not going to get any money from your $200K purchase until you are 85, I think having the gross amount of $1.3M ($200K X 8.2% compounded interest for 23 years = 1,293,679.89,) at 85 is better than being wired to a contract of $132,796 a year.

If you lived to be 95, you’d only get $1,327,960 and no flexibility to use the $1.3M. To me, that flexibility is worth at least 10-to-20%.

And… things are bound to change in the years between now and your 95th birthday. When things are changing, flexibility is useful.

Is the annuity within the IRA still? I presume it’s taxed as ordinary income later, but don’t understand the mechanism. Maybe it acts like a larger RMD at age 87.

H, as I wrote in the post… you can’t compare investments with risk directly to contracts which are (almost) riskless. I appreciate the math around compounding at an 8.2% rate, which could be a balanced portfolio return, but it’s not comparable to an (almost) riskless sequence of cash flows. If I run a Monte Carlo sim on a 60/40 portfolio with $200,000 to start for 23 years, then draw it down at $132,796 per year, OVER 30% OF THE SIMULATIONS FAIL BEFORE MY END OF PLAN. That’s not good.

And what if I live to 100? Many people do these days.45% OF THE SIMULATIONS FAIL BEFORE AGE 100.

This is a really hard this to wrap one’s head around… retirements do not run on value… they run on cash. Riskless cash flows have value. Pensions have value. Social Security has value. “Clark Friendly” annuities, not the cuss-word annuities… have value.

And keeping the $200,000 and running it myself… still leaves the Maggie / Irma problem unaddressed, which was one of my motivators to look at QLAC in the first place.

This QLAC would be 8% of my present portfolio, I would not be making a large bet or anything. It’s all rich people problems, at the end of the day.

You might consider reading the review of QLACs by Michael Kitces whose posts are approved for financial planners coninuing education credits. He runs the numbers in his Blog post from 2015 titled “Why a QLAC in an IRA is a terrible way to defer the RMD obligation” His final paragraph is: if the goal is*to defer RMDs in the first place, the value proposition of the QLAC isn’t very compelling, as the retiree takes on a significant risk of losing out on almost two decades’ worth of compounding growth just to defer RMDs, only to find that if he/she lives the QLAC distributions in the client’s 90s will be even more severe than the RMDs ever would have been… and may even be giving up economic growth along the way as well, if the retiree simply could have invested in a balanced portfolio over that multi-decade time horizon!
Disclaimer- I only scanned the long post.

My understanding is that the QLAC will not be within an IRA account wrapper, but it will be funded from an IRA with no tax implications this year. Hence the word “Qualified” they are a qualified retirement plan in and of themselves. What Is a Qualified Longevity Annuity Contract (QLAC)? (smartasset.com)

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I understand Kitces’ arguments, but they’re arguments that are incomplete or myopic.

Basically, what he’s saying is that an annuity is a bond with mortality credits, and it has inferior returns to a balanced portfolio. He’s comparing mashed potatoes alone (a side dish) to an entire full menu, and scoffing at the potatoes, “Oh, who would want just those sad potatoes, they’re incomplete”. Of course they are, no one was ever claiming otherwise.

How about if you use the annuity as a bond substitute in the portfolio, and go for more risk / more return in the rest of the non-annuitized portfolio? Then you’re comparing apples to apples.

You can’t analyze portfolio components in isolation. You have to model how the whole thing performs… how the annuity makes the entire Monte Carlo simulation run. I find it helps, with the added feature of not being to outlive your money.

RMDs? I really don’t want to have extremely bad RMDs in my 70s 80s. I will still be trying to enjoy life. It’s perfectly OK for me to defer to after 85. Why? Because medically-necessary long-term care costs are tax-deductible! I do my Mother’s taxes, and she has $0 Federal liability because her assisted living deduction wipes it all away.

Michael Kitces and that other guy, Wayne Pfau, both have their useful moments, but I’m also not their client, and I can’t run my life based on bullet points from articles they wrote. I’m from Missouri, “SHOW ME”, and to me that’s SHOW ME the effect on the actual retirement plan. Well, I can’t share my plan here for obvious reasons, but I don’t see that the QLAC harms my plan, in fact the opposite.

Kitces makes actually a very stupid and careless statement, I closed the article but it was like “Most people don’t live to XX age, so QLAC not a good bet”. It’s not about what most people live to, it’s about being able to respond to tail risk… what if YOU do happen to be very long lived?

Yes, I have never been in a car crash where seat belts and airbags would have improved my well-being. And I don’t know anyone else who would have benefitted. That is a true statement. So I should stop using seatbelts and rip out my airbags?

I’ve always been skeptical of “risk-free” investment offerings. VWELX has been around for 94 years and averaged 8.2% return.

I think if it goes casters-up the “risk-free” offerings won’t be far behind. Remember credit default swaps?

That’s catastrophism, man. Anyway, if the macro environment is so hostile such that Mass Mutual, New York Life etc can’t honor policies the balanced stock & bond portfolio is totally toast.

Life insurance and fixed annuities aren’t CDS’. Mass Mutual is 172 years old.

Flexible Retirement Planner version 04.04.01 by Random Walk LLC

The two scenarios are identical, but one uses the QLAC, and one does not. $200,000 spent on QLAC at age 62, distributions $132,796 start age 85.

Uses QLAC - annual retirement spending $149,000, probability of success 95%, median ending portfolio value $1,666,824

Doesn’t use QLAC - annual retirement spending $140,000, probability of success 95%, median ending portfolio value $1,916,790

The only “improvement” is my kids get 15% more without the QLAC. For me that’s an irrelevant difference. Me being able to spend 6% more is important. That’s a nice vacation right there, every year.

I do have an annuity w/Prudential. IBM replaced my company-funded pension with a Prudential/Fidelity immediate annuity this year.

I’m in a similar situation: wife not expected to be around much longer, RMDs starting in a few years which are going to drive me into big IRMAA and Income Tax wallops. I went a different way: I just purchased an immediate fixed payout annuity with a 15 year payout guarantee, funded from an IRA. It will provide enough current income that together with SSI and another pension will cover all my ongoing expenses. Yes, I have to pay taxes on that current income, but they will start now and be spread out. I will still have a big IRMAA and Income Tax hit at age 73, but they will be reduced.

I guess we’re thinking the same thing… spread the IRA money out over time. Terrible problem we have, but you know, I wouldn’t want her having to deal with all of this tax minutiae on my behalf.

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Based on 2022 FIT rates, jumping from $150K to $250K only raises your effective tax rate about four percent.

Look at IRMAA

That’s just $102/mo for the bump from $150K to $250k and it remains there till you top $500K. That’s pretty rarified air for most folks.