In my previous two posts, I compared how a longevity annuity differs from a traditional life annuity (here) and I described a Qualified Longevity Annuity Contract (QLAC), a special type of longevity annuity (here). Now let’s walk through the mechanics of buying a QLAC.
An Example
Larry and Andrea are two healthy, financially-savvy 65 year olds who live in New York. They’ve read the Society of Actuaries Retirement Participant 2000 Table (I told you they were financially savvy) and know that Larry has a 41% chance of living to age 85 (and a 20% chance of living to age 90), and Andrea has a 53% chance of living to age 85 (and a 32% chance of living to age 90). As a couple, there’s a 72% chance that one of them will live to age 85 and a 45% chance that one will live to age 90. Concerned that they might outlive their assets, they ask their financial advisor for quotes for a $100,000 QLAC. They don’t know who will live longer, so they ask for an annuity with a survivor benefit of 67% (if Larry or Andrea dies first, the survivor will be entitled to 67% of the monthly benefit).
Their financial advisor obtains quotes from several New York insurance companies and provides Larry and Andrea with the following information:
| Payout Age | Monthly Payment |
|---|---|
| 75 | $955 |
| 80 | $1,534 |
| 85 | $2,620 |
You will notice that the monthly benefit is noticeably higher the longer they wait. Waiting until age 80 increases their monthly payment by 60% (or about 12% per year). Waiting until age 85, on the other hand, increases their payment by a whopping 174%(!). That’s because the likelihood that either Larry or Andrea will be alive at age 75 (97%) is higher than at age 85 (72%), and the insurer only has to make payments if one of them is still alive at the time the payments begin (and then only for as long as either of them is still living).
Larry and Andrea have lots of options when buying a QLAC. For example, they could add a cost of living adjustment. This option would increase the value of their benefit once it starts, either by the annual change in the consumer price index or by a fixed annual percentage. This might be a good option if Larry and Andrea are concerned about losing their purchasing power over time due to inflation. They could also add a “refund” option. With this option, if they died before the accumulated annuity benefits received equal the annuity premiums paid, the insurer will pay the difference to a designated beneficiary.
Importantly, these options cost money. For example, adding a cost of living adjustment decreases their age 85 payout from $2,620 per month to $2,325. The addition of any guarantee, refund or option requires careful consideration.
The Bottom Line
The first thing you should do if you are concerned about outliving your assets is consider delaying Social Security. The higher inflation-adjusted benefit you get from waiting until age 70 is better than anything you can find in the marketplace. After you’ve done this, however, a QLAC like the one described above is a very efficient form of longevity insurance and may deserve a place in your financial plan.
Also see Rick Miller’s comments on QLACs in Market Watch.