An annuity can be a great investment in the future for individuals who have money they won't need to tap into for a while, such as from the sale of a home or an inheritance. Now, the IRS has finalized rules that might encourage 401(k) plan sponsors to allow employees to buy a "qualified longevity annuity contract" as part of their plans. Should you consider amending your 401(k) plan to make that possible?

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Longevity Annuity Now an Option
for Your 401(k)

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Deferred longevity annuities are designed to give retirees greater piece of
mind about their financial security in retirement. You buy the annuity today,
but it doesn't start paying out until a specified age -- let's say 85. You have
the security of knowing that if your retirement funds peter out by the time
you reach that age, a new income stream will kick in.
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Before the IRS rules were changed, the value of funds put into such an
annuity would be included with other plan assets for purposes of required
minimum distribution calculations.

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» Of course, the dollars invested in the
annuity are illiquid. If the annuity funds
represent a significant portion of the
total plan assets, when it comes time to
take a required minimum distribution at
age 70-1/2, the owner might be forced to
sell some long-term investments he or
she would prefer to keep, in order to
fund the required minimum
distributions. Thanks to the new rules
(effective for annuities bought after July
2), the investments in the annuity are
not factored into the required minimum
distribution calculations.
Note: The new rules also cover IRAs
(including those funded by rollovers from
401(k) plans), profit sharing plans, 403(b)s
and even defined benefit plans.

4. What is a QLAC?
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A QLAC is a qualified longevity annuity contract. Notice the term "qualified,"
which means there are a few strings attached, but they might not be terribly
onerous. Here's the rundown:
• The annuities must be fixed. The payout cannot vary according to the
performance of some underlying investment index (in other words,
variable annuities are not eligible).
• QLAC payouts cannot begin any later than the first day of the month the
annuitant turns 85. (However this could change if life expectancy rises
and actuarial tables are adjusted accordingly.)
• The maximum amount you can put into a QLAC is $125,000 (indexed for
inflation) or 25 percent of your account balance, if that's lower than the
fixed dollar ceiling. Any inadvertent excessive payments to a QLAC must
be returned promptly or the favorable tax treatment will be revoked.

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• QLACs cannot have a cash surrender option.
• Beneficiaries designated by retirement plan participants can benefit if the
annuity holder dies before receiving annuity benefits that add up to more
than the amount of premiums paid on the annuity contract. If, for
example, you paid $75,000 for the QLAC but died after only receiving
$50,000 in annuity payments, your designated beneficiary would get the
$25,000 difference.

6. Benefit Projections
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What would a $75,000 QLAC buy? Based on a current estimate, a 65-year-old
woman who buys this annuity today, with payments to begin in 20 years, would at
age 85 begin receiving monthly payments of about $3,190. That adds up to $38,280
annually. In simple terms, you could say the annuity would "pay for itself" if she lives
at least until age 87. Of course, that calculation fails to account for the opportunity
cost -- what could have been earned on that $75,000 over the course of the next
20 years.
If you assume a conservative 4 percent average annual return, it would not quite
double, and end up at $164,000. If beginning at age 65, a modest 10 percent of that
amount were withdrawn and spent by the retiree each year, that would only equal
$16,400 a year--considerably less than the $38,280 annual annuity payout. Even at a
more aggressive 15 percent annual withdrawal rate, the annual cash flow would be
$24,600, not quite two-thirds of the annuity payout.
On the other hand, if the retiree who bought the annuity died at age 87, nothing
would be left to heirs, whereas had she not purchased the annuity, a sizable chunk
of the $164,000 would be available for heirs. But that's the gamble one takes with
insurance, and the price one pays for peace of mind.

7. Fiduciary Duties
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If you do decide to build a QLAC option into your retirement plan, you will
assume some additional fiduciary liability. That liability pertains to the selection
of the annuity provider. Using a Department of Labor "safe harbor" fiduciary
checklist (as described in Regulation Section 2550.404a-4), you will have fulfilled
your duties. Tasks enumerated in that regulation include:
• Conducting "an objective, thorough and analytical" search for an annuity
provider
• Gathering enough data to assess the annuity provider's capacity to pay
promised benefits
• Balancing the cost of the annuity, including fees and commissions, with its
benefits, and
• If you aren't personally capable of doing all of this analysis, hiring a qualified
expert to handle it for you.
Your employee benefits professional or accountant may provide assistance in
helping you assess the decision of whether to offer a QLAC option in your
company's retirement plan.

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