Les Rosenbaum:  “I know, from your book, that you don’t think very highly of annuities. What about the Qualifying Longevity Annuity Contracts? Any thoughts?”

☞ These are annuities you buy in your IRA now — at age 60 or 70 — in a lump sum — $100,000 or $1 million — that will pay you a monthly income for the rest of your life . . . but not beginning until you turn 80, say, or 85.  Your protection in case you live to 90 or 100 or even 116.

I don’t know much about QLACs, except that you’d presumably want to pay more to buy one that includes a cost-of-living adjustment (lest inflation render the whole point of the thing moot) . . . although, because Social Security DOES have a COLA built-in, maybe if it’s cheap enough, in buying your QLAC, you’d be willing to bet on decades of very LOW inflation.

The main thing is: this is a very hard item to “shop for” – and if I were the insurance company I would price my QLACs to cover not just the actuarial cost of the product, but also the sales cost, legal cost, administrative cost, the cost of whatever hedges I’d be buying to cover my risk, and a nice fat profit.  All fair – how could they not? – but all eating into the value of the deal for you.

So basically, from a math point of view it likely wouldn’t be a great deal unless you lived a really, really long time – as I hope you will.

But from a peace-of-mind point of view, especially if you get one with a COLA (and from an insurance company you expect not to outlive, which is also an issue), I can see how it could have strong appeal . . . which is what the annuity salesman is counting on.

I concluded my email to Les by “blind-copying someone smarter than me on this just in case he wants to offer more – or Less.”

Less Antman, that is, the financial planner next to whose name at the right of this page an asterisk has been discreetly blinking 60 times a minute for 5 million minutes now (give or take).

Happily, he chose to offer more:

While Andy has already offered good reasons to be leery of QLACs, I’d like to add a couple more:

(1) The irrevocable loss of flexibility on the committed funds – In the hypothetical world of projections, nobody has unexpected expenses, needs lump sums, or has a future opportunity to gain a tax advantage from another strategy rendered impossible by the purchase of the annuity.  Real life isn’t so clean.

(2) The selection of a non-growth asset in a growth-oriented situation – Assuming someone is thinking of buying one of these at age 70 to reduce RMDs until the mandatory start of payments on the QLAC at age 85, we’re talking about 15 years of potential equity growth sacrificed for a non-growth investment.  Sure, there are no market guarantees, but a globally diversified equity portfolio that hadn’t risen significantly after 15 years would be unprecedented (while the failure of an insurer promising the payments would not be, and would be even more likely in an environment in which equities didn’t rise significantly over a 15-year period).  Fixed income investments should be thought of as ways of addressing the short-term uncertainty of equity investments, which means having liquidity to get through the next bear market.  The promise of cash 15 years out and beyond provides no such liquidity.

Longevity annuities have been around for over a decade.  The only thing new with the QLAC is it being permitted for retirement assets that otherwise were subject to Required Minimum Distribution rules.  Since this is only a deferral and packs added RMDs into fewer later years, potentially INCREASING taxes by pushing the older retiree into higher brackets, I don’t personally think this changes the equation.

Let me say, though, that there is one situation in which I might be inclined to use retirement annuities, including QLACs.  I’ve known a few retirees who were incapable of saying “no” to their children and who allowed their retirement assets to be drained by requests for money by their offspring.  The loss of flexibility in such circumstances might even be a positive.  Even there, though, I’d be inclined to use an immediate variable annuity such as the Vanguard Lifetime Income Program, which allows the use of growth investments, rather than giving up on growth.

[I should also mention that a retiree who has done a poor job of saving and investing and who will need every dollar they can get during their lifetime might find an annuity is the best strategy.  Again, though, I’d likely be recommending an immediate variable annuity such as the VLIP rather than a longevity annuity.]

If someone were to use a QLAC in spite of my reservations, I’d emphasize, as Andy did, the need for the payments to be indexed to inflation.  Note that the COLA offered by many insurers often isn’t true protection against unexpected inflation, but is merely an arbitrary percentage change in the payments each year that starts the payments smaller and goes up by a fixed percentage regardless of the actual inflation rate.  Only indexing to the CPI-U or an equivalent is true inflation protection.

In my view, Social Security alone is a sufficient guaranteed income to allow the remainder of a retiree’s portfolio to be invested for growth.  To the extent liquidity is needed for unexpected lump sums or to avoid withdrawals from the market during deep bears, it should be in the form of cash equivalents, short-term high quality bonds, or TIPS.  Warren Buffett’s directions to the trustee of his wife to keep 90% in diversified equities and 10% in short-term government securities seems like a good approach.  Annuities don’t provide emergency cash.

 

 

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