Qualified Longevity Annuity Contracts Guarantee Retirement Income
Retirement planning has many moving parts and many questions that must be answered. Things like: Can I maintain my current lifestyle? Will I have enough money during my later years? What will my tax situation be? How much risk should I be taking on?
In July 2014, the IRS approved regulations for a strategy that allows individuals to answer one of the biggest retirement questions by proactively planning for their later years. The vehicle for achieving that goal is known as a qualified longevity annuity contract or QLAC. Like other annuities, a QLAC is an insurance product that provides an income stream beginning at a future date and continuing for the rest of the person’s life. What sets the QLAC apart is the source of its funding.
The primary goal of a QLAC: late retirement income
A QLAC is funded using dollars from a traditional IRA, with a maximum contribution set at the lesser of $130,000 or 25 percent of all of an individual’s IRA balances. When the IRA funds are rolled into a QLAC, the required minimum distributions (RMDs) on those funds, which would normally kick in at age 70.5, may be deferred until distributions from the QLAC begin.
The QLAC owner must start taking income payments by the first day of the month following his or her 85th birthday (for example, a person who turns 85 on January 1 must take his or her first distribution by February 1).
While the QLAC owner is able to start taking the income stream at an earlier date if desired, postponing the income to age 85 will result in the highest level of payments. Like monthly social security or pension payments, the QLAC payments are a fixed dollar amount. They can be made on a monthly or annual basis, depending on the preference of the owner.
In order for a longevity annuity contract to qualify (in the eyes of the IRS), it cannot be tied to market fluctuations, as the primary usage of the QLAC is to provide a reliable income stream during later years that is guaranteed by the insurance company backing the contract.
Depending on actuarial underwriting, a QLAC purchased at 70 can provide a fixed payment of $25,000 ̶ $45,000 per year by the time distributions start at age 85. Unlike a variable annuity or stocks held in an investment management account, the QLAC is protected against downturns in the market. It can be an effective strategy to reduce market risk during the later years of retirement.
Premium elections and income stream options
During the application process, the QLAC owner can choose from several options that impact the duration and amount of future payments.
- Return of premium election — Protects the beneficiary of a deceased owner by returning the initial amount of premiums paid, less any distributions received.
- Lifetime income stream — Payments will only continue for as long as the owner is alive.
- Specified period election — The owner elects a certain number of years during which the beneficiary will continue to receive income payments after the owner passes away.
Keep in mind that the payments the owner will receive when distributions start will be taxable as ordinary income, since the funds initially paid into the QLAC were tax-deferred funds from an IRA.
QLACs are not for everyone
While there are benefits to creating a guaranteed income stream and deferring the tax on RMDs, QLACs are not liquid assets. Owners need to be aware that they cannot take periodic distributions as needed, and they may only be able to change the date to begin receiving payments once, if at all. In addition, when the owner starts to receive the income from the annuity contract, he or she will have to pay taxes on those dollars.
|QLAC Pros||QLAC Cons|
|Guaranteed income for life||No liquidity|
|No market risk||May cause higher tax bill when income stream starts|
|Deferral of RMDs||Lack of flexibility once the QLAC is in force|
|Return of premium protects principal during deferral period|
Here’s an example of how a QLAC works
John turned 70 last year. His IRA balances total $1 million. He will have to start taking the RMDs from his IRA this year, in the amount of $37,735.85 (the percentage is set by the IRS). John is worried about the possibility of running out of money during his later years and he likes the idea of having a guaranteed income payment at a future date.
Using a QLAC, John can set aside up to $130,000 to receive a guaranteed income stream starting no later than age 85. This reduces the balance of John’s IRAs to $870,000, which in turn, reduces the amount of RMDs he must take to $32,830.19. If John were to defer income payments until 85, he could receive a guaranteed income payment of $43,000 per year (assuming a life-only income payment option).
How we can help
As previously mentioned, a QLAC is not for everyone. The best way to determine if it is right for you is to see if it supports the retirement goals you have set for yourself and your family.