Qualified Longevity Annuity Contract

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Qualified Longevity Annuity Contract (QLAC) is how retirees secure retirement income for their future. The notion is to let people carve out a specific part of their retirement accounts for the latter half of the retirement journey. In 2014, the U.S. Treasury Department sanctioned the rules allowing IRA owners and qualified plan participants to buy QLACs. These rules are important as they give unprecedented flexibility to the people to manage retirement income by conceding a part of their retirement accounts to later in the future. 

What is a Qualified Longevity Annuity Contract (QLAC)?

Turning 72 is a significant milestone of your life if you have a traditional IRA or 401(k). That’s when you need to start taking compulsory minimum yearly withdrawals, called required minimum distributions (RMDs), from such accounts. However, what if you don’t require that money for your current living expenses and would like to get a definite lifetime income later in your retirement? The US Treasury Department’s rule has created Qualified Longevity Annuity Contracts (QLACs). Retirees can use a portion of their qualified accounts—like a traditional IRA or 401(k)—to buy a deferred income annuity (DIA) and not have that money be subject to RMDs beginning at age 72.

A qualified longevity annuity contract, in its simplest form, is a deferred income annuity funded with the assets from a qualified retirement plan. The income from this kind of annuity also termed a longevity annuity, starts years after purchase. QLACs enable Americans to have a longevity income tail in their retirement, which can exceed 30 years.

Why QLAC?

QLACs answer one of the biggest concerns of retirees by ensuring they don’t outlive their retirement savings. The 2020 Retirement Confidence Survey, carried out by the Employee Benefit Research Institute, found 3 out of 4 workers and retirees have reported that income stability is more important than maintaining wealth or preserving account balances.

A QLAC offers a guaranteed income stream for life starting from the date selected. Usually, the longer the deferral period, the higher the payout. For example, one may buy a QLAC at 60 and start their income payments at 75. 

Before the 2014 ruling on QLACs, funding a deferred income annuity (DIA) with qualified funds from an IRA was a challenge: IRAs and other tax-deferred plans like 401(k)s include RMD rules mandating withdrawals at the age of 72. 

However, there are specific rules about the amount of money one can use to fund a QLAC. Presently, people are subject to 2 limitations: 

  • Total lifetime contributions must not be more than $135,000 across all funding sources.
  • QLAC contributions from the provided funding source must not be more than 25% of the value of that funding source

How does QLAC Work?

Imagine that you own some traditional IRAs amounting to a total of $200,000 as of December 31 of the last year.

You can only use $50,000, which is 25% of $200,000 and is less than $135,000, to fund the QLAC. 

However, if the total IRA balance is worth $540,000 or even more, the maximum you can contribute to a QLAC is $135,000. Remember that in both cases, the money that is in your IRA or 401(k) is still subject to the RMDs.

Consider the example below for a better understanding.

Qualified Longevity Annuity Contract

Let’s assume your age is 70 and you are investing $135,000 in a QLAC. You can be either an individual or a couple purchasing a QLAC. The next step is to decide the age when you should start receiving income, i.e. 75 or 85.  Lastly, it would estimate the total lifetime payments if you would live to age 90 or more. 

Consider a more real-world example. Let’s assume a female near her RMD age doesn’t want her full RMD to cover current expenses. By investing a part of her traditional IRA assets in a QLAC at the age of 70, she would not need to take RMDs on the QLAC-invested assets and would get guaranteed lifetime income from the date of her choice up to age 85. In the deferral period, she would utilize her Social Security, RMDs from the leftover money in her IRA, withdrawals from investments, and other income, like part-time work or a business sale, to manage her expenses. At the age of 70, she would not need to take RMDs on the QLAC-invested assets and would get guaranteed lifetime income from the date of her choice up to age 85. If she invests $135,000 in a QLAC and defers to the age of 80, her guaranteed income becomes $15,131 a year. She would get a total of $226,965 in payments if she reached age 95—or more.

How does QLAC Benefit One’s Finances?

By investing in a QLAC, you generate a guaranteed income for the later part of your retirement life. Moreover, limiting the sum of money you withdraw every year might keep you in a lower tax bracket and let you escape the hefty Medicare premiums.

Income from a QLAC can be deferred until the age of 85, enabling mortality credits to accumulate, which leads to much higher annuity payments when started. 

The new QLAC rules also lead to the return of premium death benefits. With this rider or policy add-on, if deferred annuity buyers die, premiums they paid but have not yet received as annuity payments are returned to their accounts.

Having a QLAC releases retirees of the obligation of managing their retirement accounts in their 80s and beyond, a time when they might not want to think about the ins and outs of investments. Retirees can let go of that obligation without having to be worried about running out of their retirement savings.

A QLAC also decreases the investor’s tax load by protecting a slice of retirement account funds from RMD calculations, leading to little required distributions and possibly lower income tax liabilities. Since they are bought with pre-tax retirement savings, once you obtain income from a QLAC, the distributions are taxable at a person’s existing marginal ordinary income tax rate.

When Should the Income Start? 

A QLAC must be a part of one’s broader income plan to ensure that essential expenses are covered during retirement, such as healthcare, food, and housing—preferably with lifetime income sources like a pension, Social Security, or lifetime annuity. Determination of the income start date is based on how this income stream would best fit into one’s overall plan. Following are few hypothetical examples of how you may select an income start date:

  • A 70-year-old retiree has an existing income stream that will halt at age 75 (for instance, proceeds end from the sale of a business, the retiree ceases working part-time, inheritance income stops) may begin income at age 76 for the QLAC to cover the income that is ending.
  • A couple in their late 60s might like to consider an income stream that starts at age 80 or 85 as part of their general plan to manage their higher expected health costs later in their retirement.
  • A couple aged 65 decides to withdraw from their investment portfolio to manage expenses at the start of retirement. Still, they are worried about the potential need for it in the next 30 years or more. They might think of a QLAC that offers lifetime income to help resolve these concerns.

The Downsides of QLACs

Not everyone is benefited from or feels content with a QLAC. As with most annuities, purchasing a QLAC implies you won’t have access to or control over these funds beyond the annuity contract terms. If one dies before their QLAC matures, they might never personally benefit from this contract, which is insurance against outliving their savings. They are more likely to benefit from any annuity the longer they live.

QLACs don’t have any real liquidity. Fundamentally, you are trading a share of your retirement accounts for guaranteed income.

Cost of living adjustments (COLAs) might be available; however, this feature typically implies lower initial payments. And since this is usually a product for future income,  the cost of adding a COLA might not be justified.

The Final Thought

QLAC would enable a person to enjoy their earlier retirement years, being aware that they have some guaranteed income that they can use when needed. QLACs are a helpful addition to one’s retirement plan if they are concerned about outliving their nest egg and if they like the notion of relying on a guaranteed income stream later in their life. However, you must keep in mind that the product isn’t ideal for everyone. Be sure to consult with your financial advisor to determine if they’re suitable for your retirement plan.

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