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How Much Can Qualifying Longevity Annuity Contracts Improve Retirement Security?

In recent years, the prospect of increasing individual interest in annuitizing retirement savings has been enhanced through an insurance product designed to provide monthly benefits only after a significant deferral period in retirement. In 2014, one of the major constraints of using this type of product was eliminated when the U.S. Treasury Department and the Internal Revenue Service (IRS) issued final rules for creating a qualifying longevity annuity contract (QLAC) that would be exempt from the required minimum distribution rules that dictate distributions from DC plans and IRAs must typically begin by age 70-1/2 (significantly earlier than the age at which payments commence for these products). While it is still too early to know how individuals’ demand for these products and the insurance industry’s supply of QLAC options will eventually modify the market for longevity annuities, it is useful to model the degree to which QLACs can improve retirement security. Specifically, this paper models two scenarios under which QLACs are utilized as part of a 401(k) plan by analyzing the ability of QLACs to provide an effective longevity hedge for Boomers and Gen Xers who are simulated to participate in an in-plan offering either through a 10-year series of laddered purchases or as a one-time purchase based on the accumulated value of employer contributions from the current employer. The analysis finds that even at today’s historically low interest rates, the purchase of these products may provide a significant increase in retirement readiness for the longest-lived quartile, compared with only a small reduction for the general population. Sensitivity analysis on the QLAC premiums resulting from likely increases in future interest rates provides even more favorable results. It is difficult to predict the extent to which individual demand for QLACs will increase without an in-plan offering similar to one of the two scenarios modeled in this paper.