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What Is A Qualified Longevity Annuity Contract (QLAC)?

Kate Ashford
September 14, 2023
What Is A Qualified Longevity Annuity Contract (QLAC)?

A qualified longevity annuity contract (QLAC) is a type of annuity contract specifically designed to keep you from outliving your retirement savings. As a deferred annuity, QLACs provide you with a guaranteed stream of income later in life. In addition, they can help you reduce the retirement account withdrawals mandated by Congress, helping to defer some income taxes.

What Is a QLAC?

A QLAC is a deferred fixed annuity contract sold by insurance and financial services companies that you purchase with money from a retirement account, such as a 401(k) or an individual retirement account (IRA).

The qualified part of the name means the annuity has met the requirements set by the government for special treatment when purchased with retirement account funds. With 401(k)s and most IRAs, you also get preferential tax treatment—with an understanding that by age 72 to 75 depending on your birthday, you must begin withdrawing at least a minimum amount of money from the account every year and pay ordinary income tax on those withdrawals.

You can spend up to $200,000 of your retirement funds on a QLAC without it counting as a currently taxable withdrawal. You’ll only start paying taxes on that amount when your annuity payments begin.

Longevity alludes to the chief purpose of a QLAC: making sure you don’t outlive your money. You can buy the QLAC now and put off payments until as late as when you turn 85.

The annuity contract part of QLAC means you get a guaranteed stream of income. Your QLAC provider sends you regular income payments based on the amount you’ve deposited in the annuity, the percentage growth they guarantee and the date you want to start receiving payments. The longer you wait to start receiving income, the larger your payments will be.

One important caveat: You can’t purchase QLACs with the assets in a Roth IRA or an inherited IRA account. Since Roth IRAs don’t require you to start taking RMDs in the first place, there’s no advantage to buying a QLAC using money saved in a Roth IRA.

QLACs and Required Minimum Distributions (RMDs)

With traditional IRAs, and workplace retirement plans like 401(k)s and 403(b)s, RMDs are mandated starting at age of 73 as of this year. That rises to age 75 starting in 2033. They’re taxed at your marginal ordinary income tax rate, and the size of each year’s distribution is calculated by an IRS formula that factors in your account balance at the end of the previous year and your life expectancy.

One big selling point of a QLAC is that your contributions to the annuity reduce the balance in your retirement accounts used to calculate those RMDs.

Suppose you were born in June 1950. You’re 73 years old. Your traditional IRA balance was $400,000 at the end of 2022. Your RMD this year would be your account balance divided by 26.5 (this figure takes into account life expectancy and other factors), for a total distribution of $15,094, according to the IRS formula.

But let’s say you’ve taken $200,000 your IRA and invested it in a QLAC. You arrange to delay distributions until you turn 85. Your RMD this year would now be calculated based on a $200,000 balance, requiring you to withdraw just $7,547. That’s a difference of $7,547—and that means lower income taxes on your conventional RMD. The $200,000 you’ve spent on the QLAC won’t be taxed until you start receiving taxable annuity payments at a later date.

That’s not until 2035, based on your plan.

“One of the benefits of QLACs is that they help people who want to reduce their required minimum distributions and make their IRAs last longer,” says Stuart Ritter, a retirement planning expert for T. Rowe Price.

Steven Kaye, a financial planner in Warren, N. J., says, “People tend to spend their RMDs. So a QLAC forces people—in a good way—to leave more money in their IRAs.”

How to Evaluate A QLAC

To evaluate a QLAC, you must determine the company’s stability and then the specific product’s suitability for your needs.

You want an annuity that will provide stable income over your lifetime, so check the financial strength ratings of the annuity company through A.M. Best, S&P Global Financial Strength Ratings and the Comdex rating system. You can also review their reputation and customer satisfaction by looking at the National Association of Insurance Commissioners (NAIC) complaint score index.

Once you’ve determined a company is a good fit, review the following features to evaluate if a specific QLAC is right for you:

  1. Income start date
  2. Payout options
  3. Death benefits
  4. Fees
  5. Surrender penalties
  6. Inflation protection

Only you can know what features you are likely to want or need in the future, which allows you to customize your QLAC. Consider working with a financial advisor to narrow down your options and make sure you’re picking the right one.

QLAC Contribution Limits

At the end of last year, President Biden signed Secure Act 2.0. This major retirement reform simplified the rules governing how large of a QLAC you are allowed to buy.

Now, you are permitted to buy a QLAC for up to $200,000 from an eligible retirement plan. Previously, you were limited to the lesser of 25% of your account balance or $145,000.

The current $200,000 upper limit is a combined cap that applies to all of your eligible retirement accounts. If you have a traditional IRA as well as a 401(k) account, for instance, you cannot spend more than $200,000 overall, no matter how many accounts you take the money from and no matter how many QLACs you purchase.

Congress and the president did create one legal loophole.

“If you and a spouse both have your own eligible retirement accounts, you can each spend up to the $200,000 limit,” said Stan “The Annuity Man” Haithcock, whose nickname alludes to his field of expertise.

The $200,000 limit on QLAC premiums is a lifetime limit across all funding sources. Still, the law calls for adjustments based on inflation, and those can be yearly. Inflation must be high enough to warrant $10,000 cost-of-living adjustments, Ritter says.

When Should You Begin Collecting QLAC Income?

Choosing a start date for QLAC income payments depends on your current age, health and financial situation. The longer you defer the start date, the higher your payments will be.

To a certain extent, choosing an income start date depends on how many years you can live on the rest of your savings, and how long you think you’re going to live in general. If you’re 65 and in poor health, you probably don’t want to wait until age 85 to start receiving income payments—and you may not be a good candidate for this sort of annuity at all.

“If the probabilities are that you have a longer than average life expectancy, QLACs can be a windfall,” says Artie Green, a Los Altos, Calif.-based financial planner. “But if you have a shorter than expected longevity, of course, that works against you with any annuitization.”

“Another way to think about this is that a QLAC fills part of your income need when you’re older,” Ritter says. “It solves part of your financial jigsaw puzzle.”

Depending on your QLAC provider, you may be able to change the date your payments will start, but only before you’ve received any payments.

“Once you start annuitizing or receiving income, you can’t change [the date] with any one of the products that I know of,” Kaye says. Make sure you understand whether a date change is possible before you purchase a QLAC product.

How a QLAC Can Reduce Your Taxes

A QLAC reduces an investor’s tax burden by protecting a portion of retirement account money from RMD calculations, resulting in smaller required distributions and potentially lower income tax liabilities.

Since they are purchased with pre-tax retirement savings, once you receive income from a QLAC, the distributions are taxable at whatever your marginal ordinary income tax rate is at that time.

What Happens To A QLAC When You Die?

What happens to a QLAC when you die depends on the features of your specific QLAC. Some offer a survivor payout, also referred to as contingent annuity payments. These would continue your annuity payments to your designated beneficiary—usually a spouse—after your death.

Some annuities feature other death benefits that would return any unused premiums to your beneficiaries through a lump sum or series of payments.

If you have individuals who will depend on your annuity after your passing, you need to make sure any QLAC you choose has one of these features. Without these features in your annuity, your survivors would get nothing.

What Is a QLAC Cash Refund Death Benefit?

When purchasing a QLAC, you have the option of choosing a plan whose payments stop when you die, a plan whose payments stop when you and your spouse die (called a joint life QLAC), or a plan that will pay a refund upon your death. In that last case, if there’s any difference between the premium you paid for the plan and the sum of all payments made from the plan, it will be refunded to a named beneficiary.

“If that’s what you want, you should get what’s called a joint life with cash refund annuity,” says Haithcock. “That way, you and your spouse get income while at least one of you is alive. And 100% of your unused premium goes to your stated beneficiaries, not to the evil annuity company.”

Just remember that bells and whistle carry a price tag. Choosing a refund death benefit or joint life QLAC will lower the annual dollar value of QLAC payments you receive, or increase your policy’s upfront price.

Why Choose a QLAC?

A QLAC has several advantages for retirees:

  • Long-term income security. If you’re worried that your retirement savings might not last for the long haul, a QLAC can offer some peace of mind. QLACs provide guaranteed income later in retirement and can act as hedges against long-term care costs later in life.
  • RMD deferral. If you’re looking to minimize how much money you’re required to draw from your retirement accounts, a QLAC allows you to delay distributions on a portion of your savings up until you turn 85.
  • Principal protection. A QLAC locks in future payments, protecting your retirement money from market dips later in life. But unless you purchase an inflation rider, which will lower the initial amounts you receive from an annuity, your monthly payment may lose value over time.
  • Income for your spouse. If you set up a QLAC as a joint annuity, it will continue paying income as long as you or your spouse is still living. That said, joint annuities tend to offer lower payments due to this benefit.

Who Should Buy A QLAC?

Individuals who do not feel comfortable managing the risks of a stock portfolio in retirement but who want a steady guaranteed income should consider a QLAC. While proper management of an investment portfolio can be just as tax efficient as a QLAC, it is more complex and requires much more hands-on work. If you’d rather sit back and know that you’ll receive money every month when you need it, a QLAC is a good choice for you.

“People have to understand that a QLAC is not an investment,” Haithcock says. “It is a contract. You don’t buy it for market growth. You buy it so someone else, the insurer, takes on the risk that the market goes down. You still get your income.”

How to Manage QLAC Risks

QLACs aren’t free of downsides. Some retirement experts aren’t big fans of them. Consumers give up the chance of putting their money to work pursuing higher growth using other financial tools, such as stocks, bonds, mutual funds and ETFs.

And QLAC yields often come up short in any comparison to higher yielding securities.

“The future growth difference between money invested with a prudent investment mix and the fixed rate (offered by the annuity) can leave the QLAC investor with less money over the long run,” says Neal Nolan, a CFP in Asheville, NC.

But once you own a QLAC, the insurer is obligated to pay you the agreed upon income stream for as long as the contract calls for. “That safety is what you’re buying,” Haithcock says.

A QLAC Ladder

One way to manage this risk is to “ladder” QLACs by purchasing a series of smaller QLACs over several years, assuming rates might increase in the future.

“Laddering is also beneficial in that the older you are when you buy one, the bigger the payout,” Green says. “For example, buying a QLAC at age 65 to start paying at age 75 will have a smaller payout than buying one at age 66 to start at age 76, even if interest rates do not change over that time.”

As with any financial product that promises payouts far into the future, the financial strength of the issuing company is also a concern. Unlike banking products, annuities are not guaranteed by the Federal Deposit Insurance Corporation (FDIC).

While QLAC providers insure their products, it’s still possible for insurance to fall short. That’s why it’s important to pay attention to the financial ratings of the insurer you’re purchasing the QLAC from. You might also consider purchasing QLACs from more than one firm to spread out the risk.

“A third alternative is to buy only from a company that is a member of the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA),” Green says. “It’s like insurance for insurers and will cover some amount of the annuity payout if your insurer goes bankrupt.”

How Does A QLAC Differ From A Fixed Annuity

QLACS are typically started at a much older age than fixed annuities and offer less flexibility than fixed annuities. In general a fixed annuity will typically start providing payments shortly after a contract is purchased while a QLAC will typically start payments at a specific date in the future. QLACs also offer an RMD exclusion benefit that fixed annuities do not.

The Bottom Line on QLACs

QLACs can be a helpful addition to your retirement plan if you’re worried about outliving your nest egg and if you like the idea of counting on a guaranteed income stream later in life. But the product isn’t right for everyone. For more information on QLACs and whether they’re appropriate for your retirement plan, consult a financial advisor.

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