Qualified Longevity Annuity Contracts Can Reduce Your RMD
Article Highlights:
Purpose of a QLAC
Retirement Funds Eligible for QLAC Purchase
Monetary Limits for QLAC Purchase
Other Requirements and Regulations that Govern QLACs
Pros of QLACs
Cons of QLACs
As people live longer, the risk of outliving retirement savings becomes a significant concern. Qualified Longevity Annuity Contracts (QLACs) have emerged as a strategic tool to address this issue. This article delves into the purpose of QLACs, the types of retirement funds that can be used to purchase them, the monetary limits involved, other requirements, and the pros and cons of incorporating QLACs into a retirement plan.
Purpose of a QLAC – A QLAC is a type of deferred annuity designed to provide a steady income stream later in life, typically starting at an advanced age such as 80 or 85. The primary purpose of a QLAC is to mitigate the risk of outliving one's retirement savings. By allocating a portion of retirement funds to a QLAC, retirees can ensure they have a guaranteed income for life starting at a specified age. This deferred income can make managing the remaining retirement assets more manageable, as the retiree only needs to generate income for a fixed period before the QLAC payments begin.
Retirement Funds Eligible for QLAC Purchase - QLACs can be purchased using funds from various types of retirement accounts, including:
Traditional Individual Retirement Accounts (IRAs)
401(k) plans
403(b) plans
Eligible governmental 457(b) plans
However, QLACs cannot be purchased with funds from Roth IRAs, as Roth IRAs do not have Required Minimum Distribution (RMD) requirements while the account owner is alive, and the income from Roth IRAs is generally tax-free.
Monetary Limits for QLAC Purchase
Congress has set specific limits on the amount of retirement funds that can be used to purchase a QLAC. Initially, the limit was the lesser of 25% of the retirement account balance or $125,000, adjusted for inflation. As of 2022, the limit was increased to $145,000. The SECURE 2.0 Act, effective from December 29, 2022, further adjusted these limits by:
Repealing the 25% limit and
Allowing up to $200,000 (indexed) to be used from an account balance to purchase a QLAC
These adjustments aim to provide more flexibility and encourage the use of QLACs for longevity income protection.
Other Requirements and Regulations that Govern QLACs:
Contract Types: QLACs must be fixed annuities and cannot include variable contracts, equity-indexed contracts, or similar contracts.
Death Benefits: A QLAC may provide a single-sum death benefit to a beneficiary, equal to the excess of the premium payments made over the payments received by the employee. If the QLAC provides a life annuity to a surviving spouse, it may also offer a similar return of premium benefit after the death of both the employee and the spouse.
Premium Limits: If an annuity contract fails to qualify as a QLAC solely because the premiums exceed the limits, the contract will not fail to be a QLAC if the excess premium is returned to the non-QLAC portion of the employee's account by the end of the calendar year following the year in which the excess premium was paid.
Free-Look Periods: The SECURE 2.0 Act clarifies that free-look periods are permitted up to 90 days for contracts purchased or received in an exchange on or after July 2, 2014.
Reporting: The IRS requires the use of Form 1098-Q to report the status of longevity annuity contracts held by defined contribution plans, IRAs, and eligible governmental plans to participants and the IRS.
Pros of QLACs
Longevity Protection: QLACs provide a guaranteed income for life starting at an advanced age, addressing the risk of outliving retirement savings.
RMD Reduction: The amount used to purchase a QLAC is subtracted from the retirement account balance, reducing the RMD from the account each year until distributions from the annuity begin. This can result in lower taxable income during the deferral period.
Tax Efficiency: By reducing RMD income, QLACs can potentially lower the tax on Social Security benefits, as Social Security income becomes taxable when one-half of the taxpayer’s benefits plus other income exceeds certain thresholds.
Simplified Asset Management: With a portion of retirement savings allocated to a QLAC, retirees can focus on managing the remaining assets for a shorter period, making retirement planning more straightforward.
Spousal Benefits: QLACs can provide spousal survival rights, ensuring that the surviving spouse continues to receive income after the death of the primary annuitant.
Cons of QLACs
Illiquidity: Funds used to purchase a QLAC are generally illiquid and cannot be accessed until the annuity payments begin. This lack of liquidity can be a drawback if unexpected expenses arise.
Inflation Risk: QLACs typically provide fixed payments, which may not keep pace with inflation. Over time, the purchasing power of the annuity payments may decrease.
Complexity: Understanding the rules and regulations governing QLACs can be complex.
Opportunity Cost: The funds used to purchase a QLAC are no longer available for other investment opportunities that may offer higher returns. This opportunity cost should be considered when deciding to allocate funds to a QLAC.
Premium Limits: Although the SECURE 2.0 Act increased the monetary limits for QLAC purchases, there are still caps on the amount that can be allocated to a QLAC. For individuals with substantial retirement savings, these limits may restrict the extent to which they can use QLACs for longevity income protection.
Qualified Longevity Annuity Contracts (QLACs) offer a valuable tool for retirees seeking to ensure a steady income stream later in life and mitigate the risk of outliving their retirement savings. By understanding the purpose of QLACs, the types of retirement funds that can be used, the monetary limits, and other requirements, retirees can make informed decisions about incorporating QLACs into their retirement plans. While QLACs provide several benefits, including longevity protection, RMD reduction, and tax efficiency, they also come with drawbacks such as illiquidity, inflation risk, and complexity. As with any financial decision, it is essential to weigh the pros and cons and consider individual circumstances and goals when deciding whether a QLAC is the right choice for a retirement strategy.
Please contact this office for more information related to QLACs.