As you approach retirement, one of your biggest concerns may be outliving your savings. After all, the prospect of running out of money later in life when you’re less able to generate income is stressful. A Qualified Longevity Annuity Contract (QLAC) may help alleviate this worry by providing a guaranteed income stream throughout your later years.
Note: All guarantees are subject to the claims-paying ability and financial strength of the issuing insurer.
Understanding the Basics of Annuities
An annuity is a contract between you and an insurance company. You pay a premium, either in a lump sum or through installments, and in return, the insurance company promises to make periodic payments to you starting from a predetermined date. These payments may last for a specific period or continue for the duration of your life.
Annuities can be classified into immediate and deferred. Immediate annuities start paying out shortly after the initial premium payment, while deferred annuities begin later, often timed to align with retirement needs.
What is a QLAC?
Qualified Longevity Annuity Contracts (QLACs) are a specific type of fixed-interest deferred annuity, distinct in their structure and benefits. They are purchased using funds from retirement accounts such as IRAs, 401(k)s, or 403(b)s.
What sets QLACs apart is their tax-deferment feature. The funds in a QLAC are not taxed until you start receiving payouts, which can be deferred until age 85. This presents a significant advantage for retirees looking to manage their tax liabilities efficiently.
How QLACs Work
Many seniors in the early phases of their retirement don’t need to tap into their traditional retirement accounts (IRAs/401ks). Unfortunately, they are forced to do so because of IRS Required Minimum Distributions (RMDs). When you reach your RMD age, you must take a minimum amount of money out of your qualified plan each year.
Note: The RMD age recently changed from 70½ to 72. Be sure to clarify with your CPA or tax advisor as to which group you belong or if there are any other issues you should consider based on your tax status.
If you are in a similar situation and don’t need to take distributions, you may want to consider setting up a qualified longevity annuity.
Here’s how a QLAC typically works:
- Funding: You use a portion of your qualified retirement account to purchase a QLAC from a life insurance company.
- Deferral Period: You choose an income start date, which may be as late as age 85. The longer the deferral period, the larger your future income payments will generally be.
- Interest Accumulation: From the time of funding to when you start receiving payments, your QLAC account will be credited based on a fixed interest rate.
- Guaranteed Income: Once the income start date arrives, you’ll receive regular payments for a pre-set time or the rest of your life.
Benefits of QLACs
Converting as little as 15% of your 401(k) balance to a QLAC when you retire can boost your retirement readiness in a meaningful way. They are also fairly easy to understand, require only one upfront payment, and don’t have annual fees.
Other benefits of QLACs include:
- Longevity Protection: The primary benefit is protecting against the risk of outliving your savings, which has become even more important as life expectancies rise. With a QLAC, you can leave part of your retirement savings intact longer than you can with other retirement accounts. Properly designed QLACs may also be able to help with long-term care expenses.
- RMD Reduction: QLACs are exempt from RMD rules until age 85. This may help reduce your taxable income and allow other assets in your retirement accounts to grow longer.
- Reduced Risk: By moving funds from your qualified retirement accounts to a QLAC instead of stock market investments or other financial vehicles, you can protect your money against loss while enjoying a higher growth rate than traditional savings accounts.
- Predictable Account Growth: Because QLACs grow at a fixed rate over time, you can increase the total value of your savings and potentially receive larger payouts later on.
- Tax Benefits: The deferred taxation on QLACs allows for a more effective management of tax liabilities during retirement years.
- Inclusion of Beneficiaries: QLACs offer the option to include a spouse or other beneficiaries, ensuring that your loved ones can receive financial support after your passing. You can also set up a QLAC as a joint annuity so that your spouse is able to continue receiving income payments if you pass away.
Recent Legislative Changes
The enactment of the SECURE 2.0 Act has further enhanced the appeal of QLACs. Key changes include eliminating the previous cap of 25% of retirement account balances that could be placed in QLACs. Additionally, the maximum investment limit in a QLAC has been raised to $200,000, subject to future adjustments for inflation. These modifications give retirees greater flexibility and capacity to allocate funds towards QLACs.
Considerations Before Purchasing a QLAC
Like any financial product, QLACs have some potential disadvantages:
- Lack of Liquidity: The money you put into a QLAC is largely inaccessible until you begin to receive income payments. QLACs typically impose a 10% fee on all early withdrawals, and, any withdrawals before age 59 ½ may result in IRS tax penalties.
- Inflation Risk: While QLACs offer guaranteed income, the payment rates are typically fixed. Over time, inflation could diminish their purchasing power. You may be able to offset this issue by adding a cost-of-living rider (also called an inflation rider) for an additional cost.
- Opportunity Cost: Investing that same money in other ways might bring potentially higher returns, though there is also a greater risk of losing your principal beyond via a surrender charge.
- Provider Considerations: Like many other financial products, QLACs require a degree of trust in the company providing the product. After all, payouts for annuities are contingent upon the claims-paying ability of the company that issues them.
Note: Riders may be subject to eligibility and underwriting requirements, additional premium requirements and/or minimum or maximum coverage amounts. Availability and rider provisions may vary by state.
Who Should Consider QLACs?
QLACs may be a good fit if:
- You’re concerned about outliving your savings and want guaranteed lifetime income.
- You want to minimize your RMDs in your 70s and early 80s.
- You have retirement funds that you want to allocate to long-term income.
Important Note: The maximum amount you may invest in a QLAC in 2024 is $200,000 (increased from $135,000 in 2023). This helps ensure you maintain a diversified retirement portfolio.
QLACs as Part of a Broader Retirement Strategy
In the current financial landscape, marked by fluctuating markets and uncertain economic conditions, QLACs offer a sense of security and predictability. They help minimize the risk of outliving one’s savings and provide a strategic savings vehicle offering potentially higher returns.
While QLACs present numerous benefits, they should be considered part of a broader retirement strategy. Diversification is important in retirement planning, and QLACs can be a valuable component of a well-rounded approach. Talk to one of Annuity.com’s licensed agents to determine if a QLAC aligns with your personal circumstances and retirement goals.
