A QLAC — qualified longevity annuity contract — is a type of deferred annuity. It’s funded by a qualified retirement account — such as a 401(k), a 403(b) or an IRA — to be converted into an annuity. A QLAC is protected against stock market downturns and provides guaranteed monthly income for life.
- A qualified longevity annuity contract allows you to reduce your taxes and put off required minimum distributions (RMDs) from retirement accounts until an age specified in your contract.
- A QLAC allows you to fund the annuity with an investment from your qualified retirement account.
- A QLAC can protect your savings from market fluctuations, enhance your retirement’s financial security and provide potential benefits to your spouse and other beneficiaries.
What Is a QLAC?
Qualified longevity annuity contracts — or QLACs — are a deferred fixed annuity which you can buy with money you have put into a qualified retirement account.
QLACs are relatively new. The U.S. Treasury Department in 2014 issued rules letting people with qualified retirement plans — such as traditional 401(k) plans, 403(b) plans or traditional individual retirement accounts (IRAs) — use retirement savings to purchase QLACs. But you cannot purchase a QLAC with a Roth IRA or an inherited IRA.
The idea was to let people carve out a portion of their retirement accounts to create guaranteed income for the latter half of their retirement journey.
- Your total contributions — from all sources — cannot exceed $145,000 total.
- Contributions from any one source — 401(k), IRA, etc. — cannot exceed 25% of that account’s total.
Having a QLAC relieves retirees of the responsibility of managing retirement accounts in their 80s and beyond, a time when they may not want to think about the ins and outs of investments. Retirees can let go of that responsibility without having to worry about running out of retirement savings.
What to Know About QLAC Contracts and Taxes
Longevity annuities “can provide a cost-effective solution for retirees willing to use part of their savings to protect against outliving the rest of their assets,” according to the U.S. Treasury Department. But they can also help you cut your tax bill in retirement.
How a Qualified Longevity Annuity Contract Works
The annuity contract in a QLAC gives you a guaranteed source of income. The insurer will send you monthly payments beginning on the date you agree to in the contract.
You can put off receiving money from the QLAC until as late as you turn 85.
The amount of the payments you receive will be based on the amount of money you’ve deposited in the annuity, plus the amount of growth the insurer guaranteed on your deposits. The longer you wait to begin receiving your payments, the higher your payments will be.
QLAC Tax Advantage: Reducing Required Minimum Distributions
If you keep money in a 401(k), traditional IRA or other certain other retirement account, you have to make a required minimum distribution (RMD) each year. RMDs require retirees to withdraw minimum amounts from their retirement accounts beginning at age 72. Roth IRAs don’t require RMDs.
But when QLACs are purchased inside retirement accounts, they are exempt from RMD rules. With a QLAC, you can defer RMDs up to a maximum age of 85. The actual age varies based on your QLAC contract.
By being able to limit the amount of money you withdraw each year, you may be able to remain in a lower tax bracket and escape higher Medicare premiums. This is especially true if you plan to work beyond 72.
The IRS offers a RMD worksheet with formulas to help determine required minimum distributions at specific ages. According to the worksheet table, you take your retirement account balance as of Dec. 31 of the previous year and divide it by the distribution period associated with your age on your birthday in the current year.
The new QLAC rules also allow for a return of premium death benefit. With this rider, or policy add-on, if the deferred annuity purchaser dies, premiums they paid but have not yet received as annuity payments will be returned to their accounts.
Strategies and Considerations Before Purchasing a QLAC
When you purchase a QLAC, you’re giving up the chance of higher growth on your money in exchange for a guaranteed amount of monthly income later in life.
There are some things you should consider, including strategies for managing this and other risks associated with a QLAC.
Consider “Laddering” Multiple QLACs
Annuity laddering is a strategy that involves buying several smaller QLACs over several years. There are a couple of advantages to this strategy.
- Laddered purchases
- Staggering purchases of several smaller QLACs year after year makes sense if you think the rates will go up. This prevents you from getting locked into one fixed rate while taking advantage of higher rates in subsequent years.
- Buying as you age
- The older you are when you buy a QLAC, the bigger your payout. If you buy smaller QLACs over a series of years, the newer ones will provide higher payouts — even if interest rates don’t rise.
There are several options for laddering annuities — spreading out your principal, staggering your payout dates, taking advantage of different features in different annuities are just a few.
Cost of Living Adjustment
Cost of living adjustments (COLAs) can be added at the time of your purchase. A COLA indexes the annuity against inflation, but this feature usually means lower initial payments. And since this is typically a product for future income later in life, the benefit of adding a COLA may not be cost justified.
You’ll need to weigh this lower initial payout against your life expectancy to determine if it’s worth it for you.
Check Out the Seller’s Financial Strength
Annuities are not FDIC insured, so it’s important to make sure the company from which you purchase a QLAC is financially sound.
Sellers insure their product, but since the payout doesn’t happen for years, there are a lot of unknowns that could mean that the insurance falls short. Purchasing QLACs from multiple sellers spreads out this risk.
You can use services such as Fitch, Standard & Poors and A.M. Best to check the ratings of financial services companies before buying.
Downsides to a QLAC
Not everyone would benefit from or feel comfortable with a QLAC. As with most annuities, buying a QLAC means you won’t have access to or control over those funds beyond the terms of your annuity contract.
If you die before your QLAC matures, you may never personally benefit from the contract, which is intended as insurance against outliving your savings.
QLACs have no real liquidity. Essentially, you are trading a portion of your retirement accounts for a guaranteed income.
Who Is a QLAC Best Suited for?
QLACs are best suited for people nearing retirement, wanting a guaranteed income stream later in life and who want smaller required minimum distributions from their retirement accounts.
In this example, Harold has a family history of long life expectancies, so he expects to live as long as his father did. He has substantial retirement savings built up but is worried about outliving his savings.
In addition, he wants to continue working at his current job past 72 — and perhaps do freelance work until 77, which is his planned retirement age.
Harold must start taking required minimum distributions on his next birthday, but he doesn’t need the money he’s required to withdraw to get by. On top of that, the RMD, coupled with his income, will bump him into a higher tax bracket — and he’ll have to pay higher taxes.
Moving $150,000 from his traditional IRA into a QLAC, with payouts scheduled to start when he’s 85, might be an option.
Harold will put off having to take his required minimum distributions on the money. This will also allow him to avoid higher tax bills.
16 Cited Research Articles
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