News & Events
October 6, 2016
A great concern for many older individuals who rely primarily on 401(k) plans or traditional individual retirement accounts (IRA’s) to fund their golden years is the risk of outliving their retirement assets. To address this concern, the IRS has recently issued rules allowing individuals to use a portion of their 401(k) or IRA account balances to purchase longevity annuities.
A longevity annuity is a deferred annuity pursuant to which the insurance company will start lifetime monthly payments several years after the date that the annuity is purchased. For example, a 60 year old individual might purchase a longevity annuity with payments that start twenty years later, at age 80.
Because payments under a longevity annuity are deferred, they will, once they begin, be much larger than they would be under an annuity that starts making payments immediately. For example, a Brookings Institute estimate in 2014 shows that a 60 year old male buying an immediately commencing annuity with $100,000 will receive a monthly payment until death of $534.50. However, if payments were deferred until age 80, the monthly amount will be $2,538.70, and if they are deferred until age 85, the monthly amount will be $4,501.68.
Under the IRS rules, an individual can use up to 25% of a 401(k) or traditional IRA account balance, but not more than $125,000, to purchase a longevity annuity that begins no later than age 85. The $125,000 dollar cap applies on an aggregate basis to all accounts held by an individual. This cap will be increased for inflation in $10,000 increments, and the age 85 limit may be increased in future years to reflect improved mortality rates. Please note that the IRS rules apply only to 401(k) and traditional IRA accounts and do not apply to Roth IRA’s.
Longevity annuities have several benefits. First, of course, they ensure that a long-lived individual will not outlive retirement assets and will have a significant monthly income in later years. This assurance offers great peace of mind.
Second, the IRS allows certain features to be added to provide financial protection in the event of a retiree’s premature death. Although the monthly payment to the retiree will be reduced, the annuity can be structured so that a spouse or, subject to certain limitations, a nonspouse beneficiary can receive lifetime continuation benefits after the retiree’s death. In addition, again at the cost of a reduced monthly payment to the retiree, a return of premium feature can be added to the annuity. Under this feature, whether the retiree dies before or after the annuity start date, the premium paid for the annuity will be refunded to the retiree’s beneficiary (minus any monthly amounts paid under the annuity). Both of these features lessen the anxiety of a retiree fearful of giving up a large chunk of retirement money and then dying before or shortly after the annuity start date.
Third, once the holder of a 401(k) or traditional IRA account reaches age 70 ½, the individual must, in general, start to take taxable required minimum distributions (“RMD’s), even if these distributions are not yet needed to meet living expenses. These distributions are calculated based on the account value, but the value of a longevity annuity is disregarded in determining that value. As a result, the RMD’s are reduced, enabling those who do not need as much retirement income early on to take greater advantage of the tax shelter offered by 401(k) plans and IRA’s.
Although longevity annuities offer useful planning opportunities, there can be certain drawbacks. Clearly, they are not a good idea for individuals in poor health. They can be purchased from a 401(k) account only if the employer maintaining the plan allows them or from an IRA only if the IRA custodian allows them. Women who purchase them from IRA’s rather than 401(k) accounts may be required to use sex-based actuarial tables, which provide lower monthly payments for women than for men. Finally, they should be purchased only from the most financially sound of insurance companies.
Please note that this summary is not intended to be a complete review of all aspects of longevity annuities and they may not be appropriate for your individual situation. We will be glad to help you if you wish to explore longevity annuities at further length.