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Qualified Longevity Annuity Contracts (QLACs) are a relatively new way for retirees to use annuities inside their retirement accounts. The contracts enable people to use a portion of their savings to purchase deferred annuities to create an income stream for later in their lives.
In 2014, the U.S. Treasury Department issued rules to help retirees manage their savings and ensure a stream of regular income for the rest of their lives. These rules created Qualified Longevity Annuity Contracts, or QLACs, which represented an expansion in retirement income options.
The idea was to allow people to use a portion of their savings to purchase annuities to get a secure stream of income later while leaving the rest of their savings available for expenses and other investments.
A QLAC is a deferred annuity funded inside a qualified retirement plan like a 401 (k), a 403(b) or an IRA. A deferred annuity, also known as a longevity annuity, is a type of annuity in which the income stream doesn’t begin until years after the purchase of an annuity.
Often these annuities are purchased years before retirement with the intent of creating retirement income. Sometimes, however, they are purchased by people of retirement age to create an income stream even later in life.
Lifetime Income Without Violating Required Minimum Distribution Rules
According to the Treasury Department, 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, and can also help them avoid overcompensating by unnecessarily limiting their spending in retirement.”
There is a limit on how much of your retirement plan savings can go to a QLAC. An investor can spend the lesser of 25 percent of his or her retirement savings or $130,000 to buy a QLAC. And if the purchaser accidentally exceeds the limit, he or she may correct the mistake without disqualifying the annuity purchase.
When these longevity annuities are purchased inside retirement plans, they are exempt from required minimum distribution (RMD) rules. RMDs require retirees to withdraw minimum amounts from their retirement accounts beginning at age 70.5 even if they don’t need the money.
The Internal Revenue Service offers a worksheet with formulas to determine RMDs at specific ages. According to the worksheet table, you take your retirement account balance as of December 31 of the previous year and divide it by the distribution period that’s associated with your age on your birthday in the current year.
The number that calculation gives you will be the amount you are legally required to withdraw from your retirement savings that year.
The amount of your savings in a QLAC is not considered when determining how much money you are required to take out of your retirement savings each year. The benefit to the exemption is to allow the retiree to keep more in savings for longer.
QLACs Help Extend Retirement Savings
To show how QLACs help retirees stretch their savings, let’s say you have $400,000 in your retirement savings account. Under the rules, you can put 25 percent of that — $100,000 — in a QLAC. If you do that, you use the $300,000 that remains in your account as the starting point in determining your required withdrawal amount.
When you’re 71, for example, you divide $300,000 by 26.5, according to the IRS distribution worksheet. That shows you are required to withdraw $11,320.75.
If you didn’t have $100,000 in a QLAC, you would have to divide $400,000 by 26.5, meaning you’d be required to withdraw $15,094.34 from your retirement savings. The QLAC allows you to leave $3,773.59 more in your retirement savings under this scenario.
Benefits to Your Finances
Limiting the amount of money you withdraw each year may help keep you in a lower tax bracket and enable you to escape higher Medicare premiums. It also leaves more money for your later years.
Income from a QLAC may be deferred until age 85. This can allow mortality credits to accumulate, leading to much higher annuity payments when they begin.
The new QLAC rules also allow for a return of premium death benefit. With this rider, or policy add-on, if deferred annuity purchasers die, premiums they paid but have not yet received as annuity payments will be returned to their accounts.
Having a QLAC relieves retirees of the responsibility of managing retirement savings investments 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.
Downside of QLACs
But not everyone would benefit from or feel comfortable with a QLAC. As with most annuities, putting your money in a QLAC means you don’t have access 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 really insurance against outliving your savings. You are more likely to benefit from any annuity the longer you live.
You also will be mostly locked in to the terms of your contract, which will provide a fixed payout no matter what happens with interest rates in the ensuing years. If interest rates don’t change much, or if they go down, that’s not a problem. If they go up, then you could be behind in your yield, when compared to other forms of investment.
20 Cited Research Articles
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- Brien, M.J. and Constantijn, W.A. (2016, October 25). Innovations and Trends in Annuities: Qualifying Longevity Annuity Contracts (QLACs). Retrieved from https://www.dol.gov/sites/default/files/ebsa/researchers/analysis/retirement/innovations-and-trends-in-annuities.pdf
- Byrnes, W.H. and Bloink, R. (2015, July 20). Pros and Cons of the Longevity Annuity Contract. Retrieved from https://www.thinkadvisor.com/2015/07/20/pros-and-cons-of-the-longevity-annuity-contract/
- Carey, M. (2018, August 13). QLAC Pricing Improves AS More Insurers Offer Product & Bond Yields Rise. Retrieved from https://www.forbes.com/sites/mattcarey/2018/08/13/qlac-pricing-improves-as-more-insurers-offer-product-bond-yields-rise/#32c3959936e0
- CNN Money. (n.d.). What is a longevity annuity? Retrieved from https://money.cnn.com/retirement/guide/annuities_longevity.moneymag/index.htm
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- Haithcock, S. (2014, November 18). 13 reasons why a QLAC belongs in your IRA. Retrieved from https://www.marketwatch.com/story/13-reasons-why-a-qlac-belongs-in-your-ira-2014-11-18
- Haithcock, S.G. (2019, January 24). How to Know If You Should Buy a QLAC Annuity. Retrieved from https://www.thebalance.com/the-good-bad-and-truth-about-qlacs-146059
- Harty, C. (2019, March 25). If You Hate RMDs, You Might Love QLACs. Retrieved from https://www.nasdaq.com/article/if-you-hate-rmds-you-might-love-qlacs-cm1120445
- Internal Revenue Service. (2019). Instructions for Form 1098-Q Qualifying Longevity Annuity Contract Information. Retrieved from https://www.irs.gov/pub/irs-prior/i1098q--2019.pdf
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