Archives for June 2023

Investing Blog Roundup: “Clipping Chains” Podcast

I recently had the pleasure of being a guest on Clipping Chains — a lovely podcast that merges financial independence and rock climbing. (I rarely talk about my life outside of work here on the blog, but rock climbing has been a huge part of it for the last ~12 years.) In the interview, we discussed FIRE, the 4% rule, Social Security, a range of other financial topics, and (of course!) climbing.

You can find the episode (and some climbing photos) here:

Mike Piper: Down To The Essence Of Smart Money Management

What is a Qualifying Longevity Annuity Contract (QLAC), and Who Should Buy One?

A reader writes in, asking:

“I have a question about changes to QLACs made in SECURE 2.0. The question is, do any of the changes make them more attractive in some cases? If so, what would be the general criteria for using a QLAC? Suppose you are in the fortunate position of not needing IRA funds in early retirement. Would the costs and risks of a QLAC, now updated by SECURE 2.0, be outweighed by the advantages of deferring taxes until age 85?”

First let’s go back over the basic information here: what’s a QLAC? Then we’ll discuss for whom a QLAC might make sense — and whether/how that has changed as a result of the SECURE Act 2.0 that was passed in late 2022.

A “qualifying longevity annuity contract” (QLAC) is a special tax treatment that can be given to a deferred annuity if it meets various requirements and if it is purchased inside a traditional IRA or tax-deferred employer-sponsored retirement plan, such as a 401(k).

Deferred Lifetime Annuities in General

A basic deferred lifetime annuity works like this:

You pay a lump sum premium now (e.g., at age 65) to an insurance company, then
Starting at a specific age in the future (e.g., age 85) the insurance company begins paying you a specific amount of money every month, and they continue to do so for the rest of your life.

In other words, these are much like immediate lifetime annuities, except for the fact that the income doesn’t kick in for many years (hence, “deferred lifetime annuity”). And, because the payments don’t kick in for several years, the premium is much lower for a given level of income.

For example, as of this writing, for a 65-year-old female to purchase an immediate lifetime annuity paying $1,000 per month, the premium would be $169,731. In contrast, for a 65-year-old female to purchase a deferred lifetime annuity, for which payments begin at age 85, paying $1,000 per month, the premium would be $24,480. (These quotes are coming from ImmediateAnnuities.com.)

QLAC Tax Treatment

Generally, with a traditional IRA or 401(k), you have to start taking required minimum distributions (RMDs) upon reaching age 73 or 75, depending on your year of birth. Without special tax treatment, buying a deferred lifetime annuity that pays nothing until, say, age 80, could cause a problem if you were to buy that annuity within a traditional IRA. The annuity is not liquid, so you might end up in a situation in which the liquid IRA balance is not sufficient to satisfy your RMD.

The special QLAC tax treatment eliminates this as a potential problem. As long as the annuity meets the requirements to be a qualifying longevity annuity contract, the value of the annuity is not included in the value of your IRA — or 401(k) or other similar account — when calculating your RMD.

Requirements to be a QLAC

A deferred annuity must meet several requirements to be considered a QLAC.

First, payments must start no later than the first day of the month after the month in which you reach age 85.

Second, the annuity must not be a variable annuity or “indexed annuity” (i.e., equity indexed annuity/fixed index annuity).

Third, the annuity cannot have much in the way of bells and whistles. Optional riders that would be allowed include:

Inflation adjustments,
Survivor benefits to a designated beneficiary, provided they meet a few specific requirements (e.g., in most cases the benefit to the survivor cannot be greater than the payments that were being made to the original owner), and
A “return of premium” rider, wherein upon the death of the original owner, the designated beneficiary receives an amount equal to the premium(s) paid, minus any amount that has been paid out so far.

Finally, the total premium(s) paid for your QLAC(s) must not exceed $200,000.

What Was Changed by the SECURE Act 2.0?

Prior to the SECURE Act 2.0, the dollar limitation was lower, and the QLAC was not allowed to exceed 25% of your IRA or 401(k) balances.

In short, the changes made it so that people can buy bigger QLACs. But the changes didn’t make QLACs any more appealing. If a QLAC didn’t make sense for a given household before, it probably still doesn’t make sense now.

And in fact, if a QLAC is seen as a tool for delaying RMDs, then the SECURE Act 2.0 actually made QLACs slightly less useful, because it was that same piece of legislation that pushed the RMD age back to begin with. (That is, prior to the SECURE Act 2.0, the RMD age was 72. So QLACs effectively let you defer RMDs from 72 to 85, which is 13 years of deferral. Now, with the RMD age being 73 or 75, delaying to age 85 is fewer years of deferral.)

Who Should Buy a QLAC?

There are basically two sides to this decision:

Does the household want a deferred lifetime annuity? (That is, ignoring the tax treatment, do they want an annuity of this nature in the first place?)
Would the QLAC tax treatment be beneficial?

With regard to the first point, the value of such annuities is that they provide longevity protection at a lower cost than immediate lifetime annuities. So they’re most likely to be useful to a household that is concerned about longevity risk (i.e., in good health, and likely in that grey zone of “do we have enough?”).

But, at least in my view, the big problem with these contracts themselves is the inflation risk. To the best of my knowledge, no insurers offer QLACs with an inflation adjustment that begins at the time of purchase. (And from reading the applicable Treasury Regulation, I’m not entirely confident that such would even be allowed.) Rather, if a cost-of-living adjustment is provided, the adjustments begin when the payments begin. So the household is “on the hook” for any inflation that occurs between the time of purchase and the time the annuity payments begin.

Depending on when you buy the QLAC and when you have the payments start, that could be decades of inflation, which leaves a significant possibility that the income you ultimately receive is worth much less than you anticipated.

So when trying to determine who is the ideal candidate for a QLAC, we’re looking for a household that is concerned about longevity risk but not concerned about inflation. Frankly, I don’t really know who that would be.

As far as the tax treatment, for many households, the value of delaying RMDs from tax-deferred accounts until age 85 isn’t that valuable because they would be spending their full RMDs anyway. And that’s especially likely to be true for the households that are most exposed to the risk of portfolio depletion in long-life scenarios. In other words, the households most exposed to longevity risk (i.e., the households for whom a deferred lifetime annuity is most likely to be attractive) are the households for whom the deferral of RMDs (i.e., the unique tax planning feature of a QLAC) is least likely to be valuable.

In addition, for a married couple, if the tax planning goal of a QLAC is just to push income later into life, it’s worth noting that doing so also has the effect of pushing a greater portion of the income into the “single” filing status years instead of the “married filing jointly” years, which likely increases the applicable tax rate — though the size of survivor benefit selected for the annuity would be an important factor here.

So the ideal candidate for a QLAC is a household that is concerned about longevity risk (i.e., they’re in good health and concerned about portfolio depletion in a long-life scenario), yet they’re anticipating spending less than their RMD every year and are not concerned about inflation risk. It’s hard to think of a set of life and financial circumstances that would cause a household to be in such a position.

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June 19, 2023

Investing Blog Roundup: Assessing Retirement Preparedness

This week, two articles take very different approaches to the topic of retirement preparedness.

First, a paper from the Center for Retirement Research at Boston College uses data from the Federal Reserve’s Survey of Consumer Finances to calculate each household’s retirement preparedness and compares that assessment to the household’s own assessment

How Well Do People Perceive Their Retirement Preparedness? from Anqi Chen, Yimeng Yin, and Alicia Munnell

And then we have a survey from Fritz Gilbert, which asked pre-retirees and retirees the same set of questions, in order to find what retirees are actually concerned about versus the things that pre-retirees think they will be concerned about. (One big takeaway: 62% of retirees miss the social interaction from work, whereas only 29% of pre-retirees expect that to be an issue.)

Shining a Light on Retirement Blind Spots from Fritz Gilbert

Recommended Reading: Taking Stock by Jordan Grumet

Last year, I read Jordan Grumet’s book Taking Stock: A Hospice Doctor’s Advice on Financial Independence, Building Wealth, and Living a Regret-Free Life. (I initially encountered the book via a Morningstar The Long View podcast episode with Grumet as the guest.)

Grumet’s book made enough of an impression on me that I referenced it in the conclusion of my own book, More Than Enough. And I find that the ideas from his book are coming up more and more often in correspondence with readers, as well as discussions with clients, friends, and family.

As far as the financial advice itself, you won’t be surprised by any of it. And to be clear, I mean that as a compliment. It’s industry-standard, best practice advice — very much along the lines of what you’d expect from a book by Rick Ferri, Christine Benz, Wade Pfau, Allan Roth etc.

Where the book really shines though is in its perspective — because Grumet’s work as a hospice doctor has granted him a perspective that most of us do not have.

One of the critical and most valuable concepts from the book is the idea of conducting a life review. (This is a standard practice in hospice care, but I was unaware of such, as it’s well outside my own field.)

Grumet writes:

There is very little that is enviable about receiving a terminal diagnosis. For many, it is the worst moment in their lives. I have had this conversation over and over again in some of the most agonizing circumstances. Yet, after the initial shock dies down, a much deeper, richer period of self-evaluation and introspection often ensues. We call this process life review.
Life review is a holistic and structured process of evaluating one’s past and present, including events and memories, in an attempt to find meaning in and achieve resolution of one’s life. Often what happens is that a hospice caregiver or chaplain will sit down with a person and ask them to look back at their life.

At the end of the first chapter of the book, Grumet shares the steps for doing a life review on your own, now, rather than waiting until your last days.

Throughout the book, Grumet also shares many lessons that can be taken from other people’s life reviews. There’s a lot to learn from the dying.

Here’s the story for Tony the dishwasher, for instance:

Tony, a retired hospice patient dying of lung cancer, put it best. While conducting a life review, he told his nurse, “I left my long-standing job as a dishwasher at a restaurant to do what?”
His retirement years were spent cooking, cleaning, and—you guessed it—doing his own dishes at home. As death was nearing, he realized that maintaining his social connections at work had been giving his life meaning. But when planning for retirement, he hadn’t considered the importance of those connections. He had become so enamored with the idea of retiring that he failed to realize that “washing dishes is washing dishes.”
It didn’t matter whether he was performing this chore for his boss at the restaurant or at home for himself. While the “work” was the same, his job not only provided a salary but also connected him with people he loved.

In financial planning, we often take it as a given that retirement is the #1 financial goal for a person/household. There’s nothing wrong with such a goal (and in fact I’d argue emphatically that you should plan/save for retirement, even if you love your job), but it’s worth asking in advance: why are you retiring? What’s next? Is that better?

Different schools of thought say different things about what is necessary for a fulfilling life, but three things that come up often are autonomy (you’re in control of our own time), competence (you feel like you’re doing a good job at whatever it is that you do with your time), and relatedness (you have meaningful relationships in your life).

If you’re planning for your retirement right now, do you have a plan for how to meet all three of those needs after you leave your job?

The money decisions are important of course. But it’s critical not to let that be the only part of retirement planning that you engage in.

If you haven’t read Grumet’s book yet, I’d encourage you to do so. My own copy is heavily highlighted. I bet yours will be too.

June 5, 2023