The New 401(k) Income Option That Kicks In When You're Old
The U.S. Treasury Department has just given a tax break and its blessings to retirement savers who want to buy long-term deferred annuities in their 401(k) and individual retirement accounts.
The new rule focuses on a particular kind of annuity. These so-called deferred "longevity" plans kick in with guaranteed income when the buyer turns, say, 80 or 85 years old. For example, a 60-year-old man who spent $50,000 on a longevity annuity from New York Life could lock in $17,614 in annual benefits when he turned 80, the company said.
Like most insurance policies and traditional pension plans, these "longevity" plans take advantage of the pooling of many lives. Not everyone will live beyond 80 or 85, so those who do so can collect more income than they would have been able to produce on their own.
That takes the worry of outliving your money off the table. It also lets you take bigger retirement withdrawals in the years between 60 and 80. A saver who put 10% of her nest egg into one of these policies could withdraw as much as 6% of her retirement account in the first year instead of the safer and more traditional amount of 4 percent, estimates Christopher Van Slyke, an Austin, Texas, financial adviser.
A fee-only planner who tends to view many insurance products with some skepticism, Van Slyke likes these longevity plans for those reasons and because they convey a tax break, too: IRA and 401(k) money spent on these policies—up to 25% of the account's value or $125,000, whichever is less—is exempt from the required minimum distribution rules that force savers over 70 1/2 to make withdrawals that count as taxable income.
The insurance industry loves this new rule, too, so consumers can be excused for taking some time to consider all the costs and angles. Treasury official J. Mark Iwry announced the new rule—declared effective immediately— at an annuities industry conference on Tuesday, and it was a crowd pleaser.
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For retirement savers, the math just got harder. Should you buy such a plan? If so, when and how? What should you look for? Here are some considerations.
* You don't have to rush. The younger you are, the cheaper these annuities are. A 40-year-old male putting down that same $50,000 with New York Life would get $31,414 in monthly benefits—almost twice the payout of the 60-year-old. But there's a downside to that: Most do not have built-in inflation protection, points out David Hultstrom, a Woodstock, Georgia, financial adviser. So if you're buying a $1,200-a-month benefit now but not collecting it for 20 years, you'll be disappointed with its buying power. At a moderate 3% annual inflation rate, in 20 years that $1,200 would cover what $664 buys now.
* There are other reasons to wait. These policies are relatively new, and the Treasury's rule "will open the floodgates," Van Slyke says. Expect heightened competition to improve the policies. Furthermore, annuity payouts are always calculated on the basis of current interest rates, which remain near historic lows. A policy bought in a few years, in a (presumably) higher interest-rate environment probably would provide higher levels of income.
* Age 70 might be a good time to jump for those with lots of assets. Those required taxable distributions start the year you turn 70 1/2, so if you're worried about the tax hit of taking big mandatory distributions, you could pull some money out of the taxable equation by buying one of these policies with it. Your benefits would be taxable as income in the year you receive them.
* Social Security is the best annuity. Before you spend money to buy an annuity, use money you have to defer starting your Social Security benefits as long as possible. Your monthly benefit check will go up by roughly 8% a year for every year after 62 that you defer starting your benefits. Social Security benefits are inflation protected, unlike these annuities.
* Think of your heirs. Money spent to buy an annuity is gone, baby, gone, so you can't leave it to your kids. Some of these annuities will offer "return of premium" provisions. That means that if you die before you've received your purchase price back in monthly checks, your heirs can get the rest back. But that will probably cost you something in the first place. New York Life, for example, shaves almost $4,000 a year of annual payout for the 60-year-old who wants to add that protection to his policy. The heirs would get only cash that has been falling in value for all the years you've held the policy, not any income on that cash.
* This won't solve your long-term care problems. The more money you have tied up in an annuity when you need round-the-clock nursing care, the less you have available to pay for that care. So if you want to use a longevity annuity to give yourself some income in those later years, you should also assure you have the big bad expenses covered. That means setting aside enough other money to pay the $7,000 to $10,000 a month it can cost for full-time nursing care, or buying a long-term care insurance policy you have faith in and can afford.