QLAC Qualified Longevity Annuity Contract
Postpone RMDs with a QLAC
Most retirees don't need to tap their IRA accounts early in retirement. Yet, required minimum distribution (“RMD”) rules force them to take money from their IRAs every year starting as soon as they reach age 70-1/2.
If you're in this situation and want to avoid taking some RMDs until much later in retirement, there's an annuity which can do that for you. It's called a Qualifying Longevity Annuity Contract or QLAC, for short (pronounced cue-lack). A QLAC is a deferred income annuity whose account value is free of RMDs until you're 85.
In this article I explain what a QLAC is, how it works, and how to set one up.
If you'd also like to get an instant QLAC calculation, simply enter your age, income start date, and amount to invest. Our QLAC Calculator is free, your phone number is not required, and your quotes are viewable online.
Unlocking the mysteries of a QLAC
What exactly is a QLAC?
A QLAC is a type of longevity annuity (also known as deferred income annuity). You set up a QLAC by transferring money from any of your existing IRA or 401k accounts to an insurance company annuity. Your QLAC is designed to pay you a steady monthly income later in life.
In July, 2014, the IRS approved the purchase of QLACs with pre-tax or so-called "qualified" account money.
The annuity that makes up a QLAC isn’t a new idea. Longevity annuities have been around for years. But the way the IRS now treats a longevity annuity within a tax-deferred retirement account, such as an IRA or 401(k), has changed.
How a QLAC Annuity Works
Before we delve into the details, let’s first explain how a QLAC longevity annuity works. This is an annuity in which you pay a lump sum premium to an insurance company and then at a future date which you specify today, you begin receiving a guaranteed monthly payout amount that continues for as long as you (or your spouse) are alive.
The beauty of the longevity annuity is that the insurance company tells you today exactly how much income you will begin receiving in the future. There is no stock market or interest rate risk. The future income amount that’s quoted is guaranteed!
With a longevity annuity you get income security that starts in your old age and at an attractive price. Financial planners estimate that if you own a longevity annuity you can increase the amount you withdraw from your savings in the early years of retirement by as much as 30% because of the reassurance in knowing your income in later retirement is guaranteed by the annuity.
Another appeal of QLACs is that they are straightforward and transparent. They are easy to understand, they require only one upfront payment and have no annual fees.
No more RMD problems for Longevity Annuities
As I mentioned earlier, RMD is the acronym for Required Minimum Distributions.
RMD is the amount of money Uncle Sam requires you to withdraw each year from your IRA and 401k accounts once you reach age 70-1/2. The IRS makes you take this money out of your IRA and 401k accounts so it can tax that money. These required withdrawals are included in your taxable income.
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In July, 2014, the Treasury Department relaxed the RMD rules a bit, reflecting the government’s desire to encourage you to prepare financially for your retirement.
The new rules allow you to buy a longevity annuity with your IRA money and not worry about having to include the value of that IRA annuity in your RMD calculations from age 70-1/2 up to age 85.
So, how can buying a QLAC reduce my income taxes?
Let’s assume you have a traditional IRA and you invested the maximum allowable $130,000 into a QLAC with an income start date of age 80. If you did not buy a QLAC, that $130,000 would grow in value and when you reached age 70-1/2, your first year's RMD would be due. That amount would be added to your taxable income, and you would be obliged to pay income tax on it.
But with a QLAC, you're not forced to withdraw an RMD at age 70, nor in any of the subsequent 9 years. So the tax savings accrued from not having to withdraw RMDs for 10 years will be significant. Remember, had you not invested in a QLAC, you would have been responsible to remove RMDs from what is otherwise an IRA account. Of course, an exact calculation of your tax savings would depend on how much your IRA account grew during the 10 years and your income tax bracket at that time.
By investing in the QLAC you essentially postpone paying income tax on some of your IRA money.
How is my QLAC reported to the IRS?
Your insurance company is required to submit form 1098-Q to the IRS in order to report the status of your annuity as a Qualified Longevity Annuity Contract (QLAC). The insurance company is required to submit this form beginning with the first year in which premiums are paid, and ending with the earlier of the year in which the policyholder reaches age 85 or becomes deceased.
Once the income from your QLAC begins, you will receive a 1099-R from your insurance company. The 1099-R form reports the taxable income you've received from your QLAC.
New QLAC rules change the game
Under the new rules, as long as your longevity annuity meets certain conditions it becomes a “qualifying” longevity annuity or QLAC and is determined to meet the RMD rules even though you've reached age 70-1/2 and are not taking any income payments from your annuity until much later in life. The new regulations mean that premiums paid into a QLAC are not included in RMD calculations.
Your QLAC needs to meet certain conditions to be exempt from RMDs (until age 85). Here’s a summary of the most important features and restrictions:
1. The maximum QLAC purchase payment limit is the lesser of:
a. $130,000; applies to all applicable retirement assets (i.e., 401(k), 403(b), governmental 457(b) and IRAs)
b. 25% of aggregated IRA account values (including existing QLAC purchases) as of 12/31 of the prior year.
2. You can defer payouts only up to age 85.
4. Income options can be single or joint life, either life income or life income with cash refund. Guaranteed period or period certain options are not allowed. So if your longevity annuity meets these requirements, its value is excluded when calculating the RMD for your IRA, and when payments start on the QLAC, they are deemed to meet the RMD. The QLAC rules require insurers to report annually to the IRS on the value and status of your contract.
5. Only limited optional features are allowed including riders for inflation adjustment, survivor benefits (as long as the survivor payments are not greater than those made to you as the original owner) and “return of premium” death benefit, meaning your heirs could receive payment equal to the annuity premiums you paid to the insurer (minus any annuity payouts made to you).
How to buy a QLAC
Because QLACs are a relatively new product, only a few insurance companies presently offer contracts that meet the new IRS requirements.
It’s important to know that an annuity must be designed and labeled as a QLAC to qualify; buying a longevity annuity is not enough.
Regulators envision that most consumers will use only a fraction, say 10% or 20% of their retirement savings, for a QLAC and put the remainder towards other vehicles to generate retirement income before the QLAC starts paying out.
Beyond the QLAC basics
QLACs can also be used in more complicated annuity and financial planning strategies that are based on a concept called laddering in which you space out the maturity dates or dates on which income becomes available. The goal of these strategies is to diversify your portfolio and minimize interest rate risk. With staggered maturity dates that may stretch across years or decades, you can also plan for times when you anticipate needing more money such as for increased care or even to fund a purchase such as a retirement home.
Recap: Top 10 reasons to consider a QLAC
We’ve delved deep into the details of QLACs, so let’s recap some of the most compelling features:
1. Reduce taxes
2. Decrease RMDs
3. Plan future income
4. Enhance financial security for late retirement
5. Protect your savings from market downturns
6. No annual fees
7. Defer distributions
8. Benefits to spouses and other beneficiaries
9. Assist strategies for leaving assets to heirs
10. Potential for inflation protection
QLACs are expected to become more popular and account for a larger share of annuities purchased because of the advantages discussed here. Does a QLAC sound like a potentially good fit in your situation? Call us at 800-872-6684 for a free, no obligation conversation. We're here to help you.
You may be seeing the term QLAC a lot these days and wonder if this financial acronym is relevant to you and your needs. Here are some of the most common questions and answers our customers have had about QLACs. If a QLAC seems like a fit for you and you’d like to discuss the idea further, we’re here to help with no pressure or obligation. Give us a call at 800-872-6684 or leave a question or comment on this page.
Q. What is a QLAC?
A QLAC stands for Qualified Longevity Annuity Contract. A QLAC is a new form of longevity annuity. A longevity annuity is an investment that you buy today and begins making payments to you later in your life, such as when you reach your 70s or 80s. The difference between a longevity annuity and a QLAC is that new government rules give QLACs more favorable tax treatment.
You can now buy a QLAC with pre-tax money from your IRA or 401k, and you can hold them without taking Required Minimum Distributions (RMD) until age 85. A QLAC will reduce your income taxes.
Q. What is my RMD?
Your Required Minimum Distribution is the amount of money you are required to withdraw each year from your IRA or 401k accounts once you reach age 70-1/2. The IRS makes you take this money out of your retirement accounts so it can finally tax that money. Up to age 70-1/2 you can let your IRA grow tax-free. Beginning at age 70-1/2 these annual required withdrawals are included in your taxable income.
In July, 2014, the Treasury Department relaxed the RMD rules a bit, reflecting the desire to encourage you to save for retirement. The new rules allow you to buy a QLAC with your IRA or 401k money and not worry about having to include the value of that annuity in your RMD calculations from age 70-1/2 up to age 85.
Q. What is a longevity annuity?
A longevity annuity is a contract you buy from an insurance company. It provides you with monthly income payments that begin at a future date. When you buy the annuity, you set the start date for payments (these may be changed later) and the amounts of the payments are guaranteed by the insurer.
Q. What is different about a QLAC if it’s a longevity annuity?
While a QLAC is built upon a regular longevity annuity which has been around for a long time, the new QLAC rules have only been in place since mid-2014. To qualify for the more favorable tax treatment under these new rules, the annuity must be labeled a QLAC by the insurance company. So just buying a longevity annuity is not enough to meet the new requirements. Insurance companies are now offering QLACs that meet the IRS rules and you can find the most up to date selection of these QLACs on our website.
Q. What specific changes make up a QLAC?
The main impact of the QLAC rules is that you can defer payments on your longevity annuity held in your IRA or other retirement account until age 85 and be considered to meet the required minimum distribution (RMD) rules even though you haven’t actually begun to take income payments from the annuity contract! In other words, the premiums you pay into your QLAC are not part of the RMD calculations.
Previously, you would have been required to include the value of your annuity for RMD calculations starting at age 70-1/2. That would put some people in a bind if they did not have enough liquid assets in other IRAs with which to pay the taxes. It sometimes forced them to start taking income from their annuity before they wanted to, just to generate money to pay taxes.
Q. Are there any restrictions for a QLAC?
Yes, there are certain restrictions:
1. You can only invest the LESSER OF 25% of your non-Roth, Traditional IRA and 401k retirement account values or $130,000 (whichever is smaller). The percentage limit is calculated by looking at all your retirement plans separately and at all your IRAs collectively.
2. You can only defer payments up to age 85.
3. You can’t invest in a variable annuity or an index annuity.
4. Income payment options can only be single or spousal joint life, either life only or life income with cash refund. Non-spouse joint annuitants are limited to joint life only (not cash refund).
5. Period certain or term certain payment options aren’t allowed.
6. A commutation or cash surrender option is not allowed.
A QLAC may have additional features including a rider for inflation adjustment, a survivor benefit (as long as the survivor payments are not greater than those made to you as the original owner) and a return of premium death benefit, meaning your heirs could receive payment equal to the annuity premiums you paid minus any annuity payouts made to you.
Q. Why should I consider a QLAC?
A QLAC can give you peace of mind so you're not worrying about outliving your money. It enables you to spend on such things as travel, a vacation home or hobbies in early retirement without worrying that you're hurting your long-term financial security.
A QLAC may be ideal for someone who does not have family to depend on in their advanced age and who want to make sure they will be able to pay for additional care without being a burden.
Anyone who worries about the cost of at-home, nursing, or assisted care and want an extra level of assurance beyond other planning techniques can use a QLAC to pay for their preferred living situation in their later years.
Q. What are the benefits or advantages of a QLAC?
A QLAC allows you to reduce your RMDs and defer withdrawals from your IRA to as late as age 85. Reducing your RMD withdrawals for even a few years could help you significantly extend your retirement savings.
A QLAC gives you income security when you get to an advanced age such as your late 70s or 80s. Because of the long period between when you buy the annuity and the annuity start date, the pricing can be very attractive. The amount you would receive in payments is very significant compared to the initial premium.
Owning a QLAC can give you peace of mind to spend in your early retirement because you know that you have other resources in place if you live to an advanced age. It also offers you a way to plan for additional expenses or care you might need when you get to your later years. Some financial planners estimate this can enable you to increase you withdrawals from savings in early retirement by as much as 30%.
In addition, owning a QLAC can provide peace of mind because payments can be guaranteed to continue as long as you or your spouse are living, meaning neither of you will outlive your money.
Another advantage is knowing you have the income security from your QLAC which doesn't have exposure to stock market or interest rate risks might make you feel more comfortable with being more aggressive with your other investments.
Q. What are the drawbacks or disadvantages of a QLAC?
A QLAC has some drawbacks. It isn’t as flexible as other assets that can be easily moved among asset classes such as stocks, bonds, or mutual funds if your circumstances or market conditions change.
You may also face the risk that you might not get all of your money back if you die prematurely and you had selected a Life Only QLAC instead of a Cash Refund QLAC.
In a low interest rate environment the guaranteed monthly income amount you are locking in is not as attractive as it might be if interest rates were higher.
Q. Who should considering buying a QLAC?
A QLAC can be a good fit for many investors in different circumstances, so there is no one ideal buyer. A QLAC will work best if you have enough money to devote only a fraction (no more than 10% to 20%) of your total portfolio to a QLAC without jeopardizing either money you need currently or money to provide income in the earlier years of your retirement.
A QLAC is also more advantageous if you have a family history of living to an advanced age.
Q. How does a QLAC work?
A QLAC requires a single lump sum payment upfront. You elect the annuity start date and you know what your annuity payments will be when you agree to the contract. There are no ongoing fees. When you reach the annuity start date, you will begin receiving payments on the schedule you elected, typically monthly. To see how a QLAC would work in your circumstances, use the calculator at the top of this page. Just select your age, gender, how much you want to invest and an income start date. That will give you an idea of how much income you could expect to receive each month from your QLAC.
Q. How much could I save in taxes?
QLACs offer you the chance to reduce your income taxes. If you invested money in a stock, bond or mutual fund in your IRA, you would have to start taking distributions and paying taxes on those when you turn 70-1/2. If you put the money in a QLAC, you could wait until you are 85 to start receiving payments from your annuity. So you would save on taxes for up to 15 years compared to a traditional investment. And by deferring your income start date longer, you increase the size of your monthly annuity payments. The exact calculation of tax savings depends on projected rates of return for your annuity vs traditional investment and your income tax bracket.
Q. What is the 25% limit based on?
The total premium paid for your QLAC in IRAs (not including annuities in Roth IRAs) cannot exceed 25% of your total IRA balances (not including Roth IRAs), with IRA balances being measured as of 12/31 of the prior calendar year. The total premium paid for QLAC in an employer-sponsored retirement plan cannot exceed 25% of your account balance in that plan.
Q. What is the latest I can wait to start taking payments?
Payments must start no later than the first day of the month after the month in which you turn 85.
Q. Is there a minimum purchase age restriction?
Most companies require age 18 with no longer than a 40 year deferral of income start date from purchase.
Q. Can I have more than one QLAC or longevity income annuity?
Yes. There are advantages to splitting QLACs or longevity annuities with different insurance companies and different income start dates or features. This can be a way to have income phase in at various start points or to position yourself to take advantage of us interest rate increases. Talk to us for more information.
Q. What death benefit options are available with a QLAC?
All QLACs offer an optional “Return of Premium” feature, which must be selected at issue. This means that if you die before your annuity payments begin, your beneficiary receives a refund of the initial premium amount.
Q. What payout options are available with a QLAC?
Your payout options are limited to the following - Single Life Only, Single Life with Cash Refund, Joint Life Only and Joint Life with Cash Refund. “Life Only” means that if you pass away after payments have begun, there will be no payments made to your beneficiaries. “Cash Refund” means that if you die after payments have begun, your beneficiaries receive a lump sum return of your premium less any payments already made to you.
Q. How do I buy a QLAC?
Since QLACs have not been around very long, insurance companies are just rolling out products, and a contract must be designed and designated as a QLAC to qualify. It’s important to make sure your purchase meets all the QLAC requirements so you get the favorable IRS tax treatment. You can find the most comprehensive selection of QLACs on this website.
Q. What fees are there on QLACs?
There are no fees on QLACs. That is one of their attractions – they are straightforward, relatively easy to understand and entail no upfront or ongoing commissions or administrative fees.
Q. What is the maximum QLAC purchase age for annuitant and joint annuitant?
It varies by company but a common restriction is that annuitants cannot be older than 83 and joint annuitants cannot be older than 90.
Q. Are Roth IRAs or inherited IRAs eligible to be classified as a QLAC?
No. RMDs do not apply to Roth IRAs and inherited IRAs cannot be treated as QLACs.
Q. What if I make a mistake and put more money into a QLAC than the rules allow?
The rules have provisions that offer you some protection. Your annuity would still count as a QLAC if you return the excess premium, either in cash or in exchange for a non-QLAC annuity held in your retirement account. This must occur by the end of the calendar year following the calendar year in which you paid the excess premium. If you don’t return the excess premium by that deadline, then the entire annuity ceases to be a QLAC as of the date of the excess premium payment. If the excess goes toward a non-QLAC annuity, then the account balance must be increased to reflect that money for the purpose of calculating RMD. As you can see, it’s complicated, so you are far better off being very careful before you pay your premium than fixing a mistake later.
Q. What specific account types can hold QLACs?
They can be bought inside your IRA, 401(k), 403(b) and governmental 457(b) plan.
Q. If it is a joint payout and the owner/annuitant dies prior to the annuity date, is the joint annuitant subject to the traditional RMD rules or do they get advantage of the later income start date?
They get the advantage of the later income start date
Q. Is commutation, cash surrender or payment acceleration permitted with QLACs?
No. Commutation is a process allowed with some annuities by which you can terminate normal annuity payments and receive a lump sum distribution of the net present value. That and similar features like cash surrender and payment acceleration are not allowed with QLACs.
Q. Can a longevity annuity held in a retirement account be exchanged for a QLAC?
Yes. If an existing contract is exchanged for a contract that satisfies the QLAC requirements, the new contract will be treated as purchased on the date of the exchange. In such a case, the fair market value of the contract that is exchanged for a QLAC is treated as a premium that counts toward the QLAC limit. Executing such a move will depend on policies of the annuity issuer. For example, AIG, which introduced the first QLAC contract under the new rules, does not allow for these exchanges.
Q. Can money in an IRA that has begun distribution due to RMD rules be exchanged into a QLAC?
Yes. However, you should consult with a tax advisor to determine if a distribution must be made in order to satisfy RMD requirements for the calendar year of the purchase of the QLAC.
Q. If I hold a QLAC in my employer-sponsored retirement plan, what happens if I change jobs?
The law intends for QLACs to be “portable,” meaning that it should be possible for QLACs to be transferred from the plan or IRA in which they were purchased to another plan or IRA, either in a rollover transaction or in a trustee-to-trustee transfer. However, the final regulations did not specifically address the mechanics or requirements for this. For example, how such transfers would affect the QLAC premium limits applicable to the transferee plan or IRA. At a minimum, plan sponsors or individuals considering such transfers will need to work the insurance company issuer of the QLACs to make sure it can be done.
Q. If the QLAC owner dies prior to the annuity start date on a joint life QLAC, when must the joint annuitant start income payments?
For a spousal joint annuitant, the spouse must start income no later than the original annuity start date. For a non-spousal joint annuitant, income payments must begin by December 31 of the calendar year immediately following the calendar year of the owner’s death.
Q. Can a beneficiary roll over any death benefit proceeds?
If the owner’s death occurs before the owner’s required beginning date (RBD), the proceeds should be eligible for rollover. If the owner’s death occurs after the RBD, then the death benefit payment is treated as an RMD and not eligible for rollover. Similarly, if the surviving spouse’s death is after the RBD for the surviving spouse, then the death benefit payment is treated as an RMD and not eligible for rollover.
Q. What sort of reporting is involved with QLACs?
The IRS has said there will be a new Form 5498-A, Qualified Longevity Annuity Contract Information. It will be used by IRA custodians and company retirement plans to report QLAC information to the IRS and to you as the IRA owner. The form has not been finalized but you can see draft information here. The due date for reporting to the IRS and the owner is May 31.
Q. How will the QLAC payments I receive be taxed?
The QLAC regulations do not address taxation specifically, but experts in the field believe that taxation rules for contributions and distributions that would typically apply to a tax-qualified retirement vehicle would also apply for participants who are, or have, invested in a QLAC. This means that your payments would be taxed as income in the year that you receive them at the income tax rate that applies to your adjusted gross income, i.e. your regular tax bracket determined by your income.
Q. Are QLACs available in employer-sponsored plan?
The new rules make this possible, but it is up to individual employers to decide if they will offer this opportunity within their defined contribution plans. Experts expect this to happen gradually with some employers moving more quickly than others.