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QLACs Can Help Reduce Need for Social Security Delays

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A new factor in retirement planning this year is a fixed annuity that could allow clients to take Social Security earlier rather than delay for better benefits, according to Curtis V. Cloke.   
 
Many advisors have been recommending the Social Security delay to help clients create an optimal retirement income stream in view of their available resources. They do this because Social Security benefits gradually increase for those who delay taking income beyond their full retirement age. The increases stop at age 70. A person who can afford to wait that long will get a larger monthly benefit than they would if they claimed benefits at, say, age 67.

Today, however, “there’s a new dimension in town and it’s called QLAC,” said Cloke, the CEO of Thrive Income Distribution System, Burlington, Iowa.  QLAC stands for “qualified longevity annuity contract.”

This new dimension could, in some situations, make it unnecessary for clients to delay taking their Social Security in order to get the optimal benefits, Cloke told InsuranceNewsNet. In fact, he said, in some cases, people who purchase a QLAC actually can take their Social Security earlier than when they reach their full retirement age. (The earliest age for claiming is 62.)

The Impact
This will create more options for the client and the advisor, Cloke said. That means advisors may “need to break their old thinking about” income stream recommendations, he added.

It will also enable some clients to feel less anxious about claiming Social Security. “Most clients will delay taking their Social Security benefits if there is a mathematical reason to do so,” Cloke said. But it’s against the nature of many people to do that, so they feel uncomfortable when an advisor first recommends it.

Therefore, if an advisor can recommend a solution where the delay is not necessary to achieve the client’s income goal, that solution likely will meet with greater client acceptance.

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Cloke said he discovered that QLACs can provide some flexibility in this area while addressing specific income requirements and requests brought to Thrive’s analytics team by clients who are approaching retirement.

Created by federal regulations in July, QLACs are deferred income annuities (DIAs) for use in individual retirement accounts (IRAs) and 401(k) plans. The regulations allow plan participants to allocate up to $125,000 of plan assets into a QLAC. Such allocation will reduce the required minimum distributions (RMDs) the person must pay starting at age 70.5, with a consequent modest reduction in RMD-related income taxes.

In the past several months, carriers have been designing DIAs to meet the terms of the new regulations. In November, American General announced that its DIA Pathway Deferred Income Annuity was “eligible to be designated as a QLAC when purchased as a traditional IRA.”

As more QLACs come out, advisors will be exploring when and how to use the products with various clients, Cloke predicted.

Case History
To illustrate one possibility, Cloke pointed to the case of a mass affluent couple whose case was submitted to his firm for testing. What follows is a high-level look at the case. Values shown are rounded.

A husband and wife both had jobs and pensions, and the husband had initially wanted to retire in 2016, at age 63. The wife was six years younger, but both wanted to retire at the same time.
According to the case backgrounder, the couple first started income planning in 2007 when they had $818,000 in investable assets. At the time, the husband had initially resisted the idea of delaying Social Security benefits beyond full retirement age, citing personal reasons. They decided to move nearly $148,000 of their assets into three DIAs, each having a 3 percent annual cost-of-living adjustment (COLA) option.

Those DIA cash flows were designed to fill in the projected gap in desired income that remained after deducting the couple’s Social Security and pension benefits, Cloke said.

The projected initial monthly income, with all sources combined, was $9,000. This would gradually increase due to the 3 percent COLA, reaching about $23,000 a month by time the wife reaches age 86.
The QLAC entered the picture in November 2014, when the husband was age 61 and much closer to retirement. The case backgrounder said that the couple had learned more about the advantages of delaying Social Security and so were more receptive to structuring their retirement plan with that in mind. To do that, the husband was considering drawing down from his qualified assets to create income during the period between start of retirement and start of Social Security, Cloke said.

Testing the Options
Thrive was asked to test the husband’s idea. That testing uncovered a problem. “To make that approach work, the couple would have to take 7.7 percent a month from qualified assets,” Cloke said, noting that the test assumed a 5 percent gross rate of return on the portfolio assets. “The 7.7 percent distribution rate was just too high,” he said.

In studying possible workarounds, Thrive’s analysts tried plugging a QLAC into the plan.

The test used a joint cash refund QLAC, funded with $125,000 of the husband’s qualified money, with payouts scheduled to start at his age 85. Instead of delaying Social Security until age 70 for each spouse, the test included no delay. In fact, the test followed the couple’s stated preference, which was to start the husband’s Social Security payments as soon as he retires at age 63, and the wife’s Social Security when she too reaches age 63.

Cloke said he was surprised to see that the plan with the QLAC included would reduce the distribution rate from the qualified assets to just 2.5 percent (from the 7.7 percent rate revealed by the previous test).

In addition, because of the QLAC, the RMD-related taxes decreased between ages 70.5 and 85, he said.

Such a plan means the clients would not have to delay Social Security until age 70 in order to meet their stated retirement income goal, Cloke said.  The plan would provide the couple with a total guaranteed monthly income – with the DIAs, QLAC, Social Security and pensions combined – of $18,800 starting when the husband reaches age 85, he said. “This income will continue, with 3 percent inflation, until the last spouse dies.”

At age 86, the wife would still have a guaranteed income of $23,000 a month, as in the earlier version of the couple’s plan.  

In addition, Cloke said, the portfolio will likely have $100,000 more in it when the wife reaches age 86 than would have been the case under the initial projections from 2007. “That’s a projection based on testing, not a guarantee, but the income will be guaranteed, regardless of portfolio performance.”

In this example, the QLAC was set to start making payouts when the husband reaches age 85, which is the maximum age specified in the federal QLAC regulations. But the clients retain the flexibility to change the QLAC income start date to sometime earlier than 85, Cloke said, adding, “Making such a change will impact the income payments, but clients can do it if they wish.”

Not Too Complicated
Are plans like this too complicated for most advisors to design and present to clients, or too complicated for clients to work with?  “I don’t think so,” Cloke said. “It’s a fairly elementary process, once it’s understood.”

The main points to remember are two-fold, he said. First, QLACs will increase retirement planning options and flexibility. Second, in some cases, QLACs can help advisors structure a plan that does not require the client to delay Social Security.
 

Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected] [email protected].


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