Many people dream of the retirement that includes walking along the beach with a loved one, spending the nights in hotels, and eating dinners that include good food, wine, and candlelight. The reality can be that for some, at least for a while. On the other side of the coin, with people living well into their 80’s, 90’s and even the century mark, retirement funds run out eventually.
The good news is that people are living longer and enjoying retirement. Thousands of Baby-Boomers are entering retirement every day. Many retirements include budgets to travel, and spend rather lavishly. On the other hand, the bad news is that people are living longer and NOT enjoying retirement. Statistically, many people enter retirement with under $30,000 in assets and even if they begin retirement, cash heavy, if they live another 30 to 40 years, their assets are usually gone by that time.
The Issue with the Well Known Retirement Accounts
Unfortunately, the Internal Revenue Code itself contributes to the problem, even when people dutifully save. There are many qualified retirement plans out there for individuals including the 401k, IRAs and SEP’s for instance that are set in place by the Code. The devices are useful in that they allow deductible contributions or non-taxable distributions in many different scenarios that individuals benefit from.
The problem with this is that along with the good, is the bad. A creature known as the Required Minimum Distribution (RMD) still exists. It is required once a person hits the age of 70 ½. The rule is generally that an individual MUST take an RMD or face tax consequence of 50% of the money required to be distributed in that year.
This, in the past, has led to many retirees taking the distributions well before they need the money. As we all know, once they money is out of the jar and into our pockets, it is much easier to spend. So too goes for retirees and unfortunately they run out of money with potentially decades in retirement to go.
The IRS’s Response
In response to the issue, the IRS has come up with the Qualified Longevity Annuity Contract (otherwise known as the QLAC) through years of study and development. Many people tend to be upset with the IRS overall, but this is one thing they got right.
First a QLAC is an annuity contract that meets certain requirements and is purchased using funds from retirement accounts such as traditional IRAs, 403b plans, and eligible government plans. The advantage to the QLAC, compared to the IRA, is that Required Minimum Distributions (RMD) do not begin until the individual turns the age of 85. The maximum purchase price of the QLAC cannot exceed the lesser of $125,000 or 25% of the total assets of the retirement plan from which the assets are used to purchase the plan. The payments must be level and the must be in the form of a life annuity.
On the down side, there may be a small cash surrender value or no cash surrender value at all. For example, a 50 year old taxpayer purchases a QLAC and subsequently retires at the age of 65 planning on utilizing Social Security, an IRA, and this QLAC that he purchased 15 years ago. Upon walking out the door, on the last day at his job at 5:01 pm, he is hit by a bus and tragically dies of his injuries. While one tragedy is that he died, the other (much lesser of course) tragedy is that of his income. Not only will he lose most of his Social Security income, he will lose his QLAC as well.
When Congress enacted the legislation that begat the Individual Retirement Account and many other retirement plans, the average life expectancy was around 70 years of age. The fact is many retirees run out of money during retirement If you have any questions please call the professionals at The Center at (618) 997-3436.
By: Dr. Bart Basi at the Center for Financial, Legal and Tax Planning for Transworld M&A Advisors