One of the challenges in retirement planning is assuring the retiree does not outlive his or her available retirement assets. One product that may assist in that planning is a “longevity annuity.” A “longevity annuity” provides an income stream that commences at a future advanced age (e.g., age 80 or 85) and continues for as long as the individual lives. It is usually purchased at the time an individual retires, say at age 65 or 70.
For many people, the only source of premiums for purchasing a longevity annuity is their qualified plan retirement account or IRA. Purchasing a longevity annuity inside a qualified retirement may create a tax qualification issue. (The same issue may exist with an IRA but our discussion will be limited to qualified plans, 403(b) plans and eligible government 457 plans which are collectively referred to as “Qualified Plans.”) Qualified Plans, such as a 401(k) plan, generally require that participants’ account balances are distributed during the participant’s expected lifetime of the participant or the expected lifetimes of the participant and a designated beneficiary. These rules are known as the required minimum distribution or “RMD” rules. Distributions must begin no later than April 1 of the calendar year following the later of the calendar year in which the participant (i) attains age 70 1/2 or (ii) retires (but only if the participant is not a 5% owner).
The problem is that the value of an annuity contract purchased in the plan account is included in the participant’s account balance and subject to the RMD rules. Acknowledging a need for deferred annuities commencing at an advanced age, the IRS has issued regulations that modify the RMD rules to provide that the value of a qualifying longevity annuity contract (or “QLAC”) is excluded from the participant’s account balance prior to the commencement of annuity payments for purposes of determining the participant’s RMD, provided that the following requirements are satisfied:
The QLAC must provide that distributions commence not later than a specified annuity starting date that is no later than the first day of the month following the month in which the participant attains age 85;
Premiums paid from the participant’s account balance to purchase the QLAC are limited to the lesser of (i) 25% of the participant’s account balance, or (ii) $125,000 (to be adjusted for cost-of-living increases);
At the time of issuance, the participant must be informed that the contract is intended to be a QLAC;
The contract must not be a variable contract, indexed contract or similar contract; and
The contract provides that after distributions commence the distributions must satisfy other requirements relating to annuities (e.g., limitation on increasing payments).
A QLAC may include optional features, such as a feature that guarantees return of premiums paid under the contract if the participant (and/or surviving spouse, if applicable) dies before receiving the value of the premiums paid, if certain requirements are met.
As with any other designated plan investment option, the decision to offer it is a fiduciary act governed by the Employee Retirement Income Security Act of 1974 (“ERISA”) that must be undertaken prudently and solely in the interest of plan participants and beneficiaries. This means investigating the annuity option to be offered and making a prudent decision whether or not to offer the option consistent with that investigation. Obviously, the advice of your financial advisor will be extremely important in making this decision. Further, a fiduciary must periodically monitor service providers and investment options to assure that they are prudent for the plan and plan participants. This process is no different from that required to choose any of the plans designated investment options.
The Department of Labor has provided a safe harbor for satisfying fiduciary duties relating to a plan sponsor’s selection of an annuity provider and contract for distributions from an individual account plan. It is suggested that those safe harbor rules be followed.
By: Steven Sokolioc, Esq.