Tuesday, February 9, 2016

QLACs vs. Deferral of Social Security Commencement, Part 2

I received a fair amount of feedback from readers who took issue with various aspects of my post of January 31, 2016, “Which is the Optimal Strategy?  Deferring Commencement of Social Security, Buying a QLAC or Neither?”  Turns out that the January 31 post might not have been my best ever.  In it I said, “Which is the optimal strategy?  Well, that depends on the retiree’s age of death.  If he dies before age 85, he is better off under the commence immediately with no QLAC alternative.  If he dies on or after age 85 and before age 88, he is better off under the defer to age 70 strategy.  If he dies on or after age 88 and before age 95, he is better off under the commence Social Security now and buy a QLAC commencing at age 80 strategy, and if he dies on or after age 95, he is better off under the commence Social Security now and buy a QLAC commencing at age 85 strategy.”

Ok.  Well, nobody’s perfect, especially me.  Since I do these calculations myself, I’ve come to the conclusion that I need more competent staff.  Turns out the comparisons are significantly more complicated than I implied.  In this post, I will attempt to gracefully back away from the above statement and perhaps even leave my readers with a few items of information that they may find to be of value.

Here are some of the problems with the previous post:

More than one reader indicated that the results would be different with different assumptions.  I agree.  The use of higher nominal discount rates (but the same real 2%) would lower the value of the QLAC options relative to the Social Security options, all things being equal. 

Other readers noted that I did the comparison for a single male and values of Social Security could be higher for married couples.  I agree. 

Ben Peters, Financial Planner at Burton Enright Welch, pointed out to me that if I had gone the next step and requested a QLAC quote from the Immediateannuities.com site instead of simply relying on the website quote of $31,524 per annum starting at age 80 (with no death benefit protection either before or after commencement), I would have received an actual quote of only about $26,112 per year for a $100,000 premium.  I have no idea why such a disparity exists (and it didn’t seem to exist for the QLAC commencing at age 85), but such a disparity will certainly have a big impact on any comparisons and reduce the value of this option.  I went back to the website and confirmed that such a disparity still exists (or at least it did yesterday).  The news from Mr. Peters was depressing to me for two reasons:  1) my trust in the Immediateannuities.com quotes is somewhat shaken and 2) I found out that Mr. Peters is the son of an actuary (younger than I) with whom I worked, so not only am I feeling less competent, I’m also feeling old.  

I actually screwed up a couple of the calculations.  The good news here (if there is any) is that I discovered these calculation errors when I started using our new improved spreadsheet.  

Based on facts I assumed, the hypothetical retiree would experience cash flow problems if he took $100,000 of his $400,000 in accumulated savings and purchased a QLAC of $52,884 commencing at age 85 and all the assumptions I made were realized in the future.  So, while the present values (or at least most of them) are correct for the QLAC commencing at age 85 scenario, the runout tab of the new spreadsheet shows that the retiree would run out of savings before the QLAC commencement age if he tried to have a constant real dollar spending budget.  To avoid these cash flow problems, I estimated that the hypothetical retiree would have to limit his QLAC purchase to about $50,000, or about 12.5% of his pre-purchase accumulated savings.

Is there some value here?

Here is what I learned:

I’m not perfect.

I need to check and double check my work (or get better and younger staff).

Website quotes may not be accurate.

At this time, based on the revised QLAC quote and all the other (possibly flawed) assumptions used in the January 31 post, it appears that the defer Social Security to age 70 strategy is the winner among these strategies for deaths on or after age 85 and before age 92.  Readers can use the new spreadsheet to confirm this if they want. 

QLACs that commence at age 80 are less likely to present cash flow problems than QLACs that commence at age 85.   If you do purchase a QLAC commencing at age 85, be sure that you (or your financial advisor) look at future expected cash flows, especially if the premium for such QLAC exceeds about 10% of your pre-purchase accumulated savings.  Having more accumulated savings or other sources of immediate income (such as a pension benefit) can help with this cash flow problem.  The runout tab of our new spreadsheet can help with this exercise.