What Is A Qualified Longevity Annuity Contract (QLAC)?

A Qualified Longevity Annuity Contract, or QLAC, is a type of annuity contract specifically designed to keep you from outliving your retirement savings. As a deferred annuity, QLACs provide you with a guaranteed stream of income later in life. In addition, they can help you reduce the retirement account withdrawals mandated by the Congress at age 72, helping to defer some income taxes.

How Does a QLAC Work?

A QLAC is a deferred fixed annuity contract sold by insurance and financial services companies that you purchase with money from a retirement account, such as a 401(k) or an individual retirement account (IRA).

The qualified part of the name means the annuity has met the requirements set by the government for special treatment when purchased with retirement account funds. With 401(k)s and most IRAs, you also get preferential tax treatment—with an understanding that by age 72, you must begin withdrawing a minimum amount of money from the account every year and pay ordinary income tax on those withdrawals. But you can spend up to $135,000 of your retirement funds on a QLAC without it counting as a currently taxable withdrawal. You’ll only start paying taxes on that amount when your annuity payments begin.

Longevity alludes to the chief purpose of a QLAC: making sure you don’t outlive your money. You can buy the QLAC now and put off payments until as late as when you turn 85.

The annuity contract part of QLAC means you get a guaranteed stream of income. Your QLAC provider sends you regular income payments based on the amount you’ve deposited in the annuity, the percentage growth they guarantee and the date you want to start receiving payments. The longer you wait to start receiving income, the larger your payments will be.

One important caveat: You can’t purchase QLACs with the assets in a Roth IRA or an inherited IRA account. Since Roth IRAs don’t require you to start taking RMDs in the first place, there’s no advantage to buying a QLAC using money saved in a Roth IRA.

QLACs and Required Minimum Distributions (RMDs)

With traditional IRAs, and workplace retirement plans like 401(k)s and 403(b)s, RMDs are mandated when you turn 72. They’re taxed at your marginal ordinary income tax rate, and the size of each year’s distribution is calculated by an IRS formula that factors in your account balance at the end of the previous year and your life expectancy.

The big selling point of a QLAC is that your contributions to the annuity reduce the balance in your retirement account used to calculate those RMDs.

Suppose you have $400,000 in a traditional IRA when you turn 72. According to the IRS formula, your RMD that year would be your account balance divided by 25.6 (this figure takes into account life expectancy and other factors), for a total distribution of $15,625.

Let’s say you’ve taken 25% of your IRA ($100,000) and invested it in a QLAC, which has no required distributions until you turn 85. Your first RMD at age 72 would now be calculated based on a $300,000 balance, resulting in a distribution of $11,718. That’s a difference of about $3,900—and that means lower income taxes on your conventional RMD. The $100,000 you’ve spent on the QLAC won’t be taxed until you start receiving taxable annuity payments at a later date.

“The properties of a QLAC are absolutely wonderful for people who want to avoid at least part of their minimum distributions and make their IRAs last longer,” says Steven Kaye, a certified financial planner (CFP) in Warren, NJ. “People tend to spend their RMDs. So a QLAC forces people—in a good way—to leave more money in their IRAs.”

QLAC Contribution Limits

Contributions to a QLAC are limited to the lesser of $135,000 or 25% of your qualified account balance. That means you can contribute up to $135,000 if you have at least $540,000 of qualifying assets and up to 25% of total assets if you have less than $540,000.

For example, if you have an IRA with a balance of $400,000, you can purchase a QLAC for up to $100,000, or 25% of your account balance.

Limits apply depending on what sort of retirement account you’re using to fund the QLAC, and the account balances you hold in different retirement plans. Here’s how it works:

1. An investor has $270,000 in one IRA and $270,000 in a second IRA. That investor can purchase a QLAC in either account for $135,000 (up to 25% of the total balance of all IRAs).

2. An investor has $270,000 in one IRA and $270,000 in a 401(k) account. That investor would be able to purchase a $67,500 QLAC from the IRA account and a $67,500 QLAC from the 401(k) account (up to 25% of each plan balance).

The $135,000 limit on QLAC premiums is a lifetime limit across all funding sources, although the cap may be adjusted periodically for inflation. The 25% limit is calculated as follows:

1. If you’re funding the QLAC from an IRA, the limit is calculated using the total value of all traditional IRAs you hold as of December 31 of the previous year.

2. If you’re funding the QLAC from a 401(k), 403(b) or 457(b) plan, the limit is calculated using the individual plan’s account value on the previous day’s market close.

3. If you’ve purchased a QLAC in the past, you should contact a financial professional for help calculating your current 25% limit.

When Should You Begin Collecting QLAC Income?

Choosing a start date for QLAC income payments depends on your current age, health and financial situation. The longer you defer the start date, the higher your payments will be.

To a certain extent, choosing an income start date depends on how many years you can live on the rest of your savings, and how long you think you’re going to live in general. If you’re 65 and in poor health, you probably don’t want to wait until age 85 to start receiving income payments—and you may not be a good candidate for this sort of annuity at all.

“If the probabilities are that you have a longer than average life expectancy, [QLACs] can be a windfall,” says Artie Green, a CFP in Los Altos, Calif. “But if you have a shorter than expected longevity, of course, that works against you with any annuitization.”

Depending on your QLAC provider, you may be able to change the date your payments will start, but only before you’ve received any payments.

“Once you start annuitizing or receiving income, you can’t change [the date] with any one of the products that I know of,” Kaye says. Make sure you understand whether a date change is possible before you purchase a QLAC product.

How a QLAC Can Reduce Your Taxes

A QLAC reduces an investor’s tax burden by protecting a portion of retirement account money from RMD calculations, resulting in smaller required distributions and potentially lower income tax liabilities.

Since they are purchased with pre-tax retirement savings, once you receive income from a QLAC, the distributions are taxable at your current marginal ordinary income tax rate.

What Is a QLAC Cash Refund Death Benefit?

When purchasing a QLAC, you have the option of choosing a plan whose payments stop when you die, a plan whose payments stop when you and your spouse die (called a joint life QLAC), or a plan that will pay a refund upon your death. In that last case, if there’s any difference between the premium you paid for the plan and the sum of all payments made from the plan, it will be refunded to a named beneficiary.

Choosing a refund death benefit or joint life QLAC will lower the annual dollar value of QLAC payments you receive.

Why Choose a QLAC?

A QLAC has several advantages for retirees:

1. Long-term income security. If you’re worried that your retirement savings might not last for the long haul, a QLAC can offer some peace of mind. QLACs provide guaranteed income later in retirement and can act as hedges against long-term care costs later in life.

2. RMD deferral. If you’re looking to minimize how much money you’re required to draw from your retirement accounts, a QLAC allows you to delay distributions on a portion of your savings up until you turn 85.

3. Principal protection. A QLAC locks in future payments, protecting your retirement money from market dips later in life. But unless you purchase an inflation rider, which will lower the initial amounts you receive from an annuity, your monthly payment may lose value over time.

1. Income for your spouse. If you set up a QLAC as a joint annuity, it will continue paying income as long as you or your spouse is still living. That said, joint annuities tend to offer lower payments due to this benefit.

How to Manage QLAC Risks

QLACs aren’t free of downsides. Some retirement experts aren’t big fans of QLACs because investors are locking in growth at a low fixed rate, giving up the chance of higher growth using other means.

“The future growth difference between money invested with a prudent investment mix and the fixed rate [offered by the annuity] can leave the QLAC investor with less money over the long run,” says Neal Nolan, a CFP in Asheville, NC.

One way to manage this risk is to “ladder” QLACs by purchasing a series of smaller QLACs over several years, assuming rates might increase in the future.

“Laddering is also beneficial in that the older you are when you buy one, the bigger the payout,” Green says. “For example, buying a QLAC at age 65 to start paying at age 75 will have a smaller payout than buying one at age 66 to start at age 76, even if interest rates do not change over that time.”

As with any financial product that promises payouts far into the future, the financial strength of the issuing company is also a concern. Unlike banking products, annuities are not guaranteed by the Federal Deposit Insurance Corporation (FDIC).

While QLAC providers insure their products, it’s still possible for insurance to fall short. That’s why it’s important to pay attention to the financial ratings of the insurer you’re purchasing the QLAC from. You might also consider purchasing QLACs from more than one firm to spread out the risk.

“A third alternative is to buy only from a company that is a member of the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA),” Green says. “It’s like insurance for insurers and will cover some amount of the annuity payout if your insurer goes bankrupt.”

The Bottom Line on QLACs

QLACs can be a helpful addition to your retirement plan if you’re worried about outliving your nest egg and if you like the idea of counting on a guaranteed income stream later in life. But the product isn’t right for everyone. For more information on QLACs and whether they’re appropriate for your retirement plan, consult a financial advisor.

Source: https://www.forbes.com/advisor/retirement/what-is-qualified-longevity-annuity-contract-qlac/

How Does a QLAC Work?

QLACs and Required Minimum Distributions (RMDs)

QLAC Contribution Limits