A qualified longevity annuity contract, or “QLAC”, is a retirement withdrawal tool. It can be a helpful part of your retirement withdrawal strategy. A QLAC allows you to use the money in a qualified retirement plan to purchase a deferred income annuity without running afoul of required minimum distribution rules.
In this article I’ll explain why qualified longevity annuity contracts exist. I’ll also explain what you need to know to decide if you should use one for your own retirement income plan.
QLAC Background: Why do they Exist?
There’s a lot more to retirement than simply quitting your job. You already know that or you wouldn’t know who I am and you wouldn’t be reading this article. You need a well-crafted plan for how to spend your savings. Taxes, investments, and life expectancy all play a key part in how you withdraw from your accounts.
One of biggest issues you face when making a plan is to ensure that you don’t run out of money too soon. In fact, that is the single most cited retirement fear.
Without going down a rabbit trail discussing ALL the possible ways to do that, one way is with a deferred income annuity.
Deferred Income Annuity
With a deferred income annuity you use a portion of your savings to purchase a guaranteed stream of payments that begins in the future. In other words, you give up a lump sum today in exchange for knowing that you’ll receive “X” number of dollars per year starting in the future.
Think of it as putting a backstop on your retirement savings. Even if the market tanks and you run out of other savings you still have your guaranteed stream of payments.
Because you defer the receipt of payments until later, often many years (decades) later, a deferred income annuity will cost much less than an immediate annuity.
This is an incredibly effective way to have some peace about the risk of living too long.
What About RMDs?
Here’s the rub. Say you purchase that deferred income annuity inside a retirement account because that’s where your money is. Logical right? Well, by locking up that money in a deferred income stream you’ve just made it inaccessible to withdraw from for the purpose of taking RMDs.
In an extreme example, let’s say you put every bit of your 401(k) money into a deferred annuity (bad idea) and that annuity is set to start paying you at age 80. You’d have no accessible money left to take your required minimum distributions when you turn 72.
The sneaky thing about required minimum distributions is that whole “required” part. There are steep penalties for missing your RMD. If you can’t access the money in your account to take a distribution, you’ll miss it.
That’s a problem!
Enter the QLAC
Recognizing that a deferred income annuity can be a viable part of a retirement income strategy, the IRS allows a way around this RMD issue. Qualified Longevity Annuity Contracts are specifically designed to allow you to purchase a deferred income annuity without having to worry about RMDs.
If you purchase a QLAC inside your retirement account you can effectively disregard the amount spent on the QLAC when figuring your RMDs.
For example, say you have $1,000,000 in your IRA. You decide to use $100,000 to purchase a QLAC, and the payments will start AFTER your RMDs are supposed to start. You’ll only have to include the remaining $900,000 in your RMD calculation.
Your RMDs will be lower, which means your tax bill will be lower too.
However, there are certain requirements that must be met for a QLAC to be a QLAC instead of just another deferred income annuity subject to RMDs.
There are limits that restrict how much you can put into a qualified longevity annuity contract. These limits relate the portion of your retirement account that can be used to purchase a QLAC (the premium) as well as a total dollar amount.
For 2020, you can use 25% of your account balance, up to a maximum dollar amount of $135,000. You’ll run into that $135,000 limit once your retirement account balance reaches $540,000. The amount is calculated on your balance as of December 31 of the previous year, just like RMDs.
Back to our example. For a $1,000,000 IRA you could use $135,000 to purchase a QLAC. You can’t use a full 25% of your account because you run into that $135,000 limit.
A QLAC must be specifically designated as a QLAC. This requirement is easy enough. Before you purchase a deferred annuity contract, simply make sure it is clear that the contract is indeed a QLAC.
QLAC payments must be scheduled to being no later than when you turn 85. They can begin sooner, such as when you turn 75, you just can’t use a QLAC to defer payments until 95, for example.
Keep in mind the longer you defer the income stream, the cheaper it will be to buy the QLAC. That is based on the easily understood logic that lifetime payments to an 85 year old won’t last as long as lifetime payments to a 65 year old.
You’ll be able to get current quotes and compare different deferral ages when you get ready to buy one.
Some annuities have market-based values that fluctuate. However, to qualify as a QLAC the payments must be fixed.
It is acceptable for the payments to increase with inflation. However, that extra benefit will make the cost a little higher.
Should I Buy a QLAC?
A QLAC makes the most sense for you if you want to insure against the risk of outliving your money. This is particularly helpful in regards to the risk of living an unexpectedly long time.
A QLAC would allow you to spend your savings and enjoy retirement knowing that you have the income from the QLAC waiting for you in your later years.
Remember that Social Security also pays for life. Before you purchase a QLAC make sure to consider your income need beyond what Social Security will provide. If Social Security covers your basic needs you may not need a QLAC.
QLAC Payout Options
You’ll need to decide how you want your QLAC to pay. You have a few options.
The simplest is the sing life payout option is the simplest and cheapest. You’ll receive a payout for as long as you live.
If you have a spouse make sure you consider their financial security in unfortunate event that you die. A joint payout option would continue the annuity payments to the surviving spouse.