As people live longer, the risk of outliving retirement savings becomes a pressing concern. Qualified Longevity Annuity Contracts (QLACs) have emerged as a strategic tool to address this issue. Designed to provide guaranteed income later in life, QLACs can help retirees achieve financial security in their golden years.
In this article, we’ll explore the purpose of QLACs, the types of retirement funds eligible for purchasing them, monetary limits, regulatory requirements, and the pros and cons of incorporating QLACs into your retirement plan.
What Is a QLAC?
A Qualified Longevity Annuity Contract (QLAC) is a deferred annuity funded with retirement account assets. Its primary purpose is to provide a steady income stream at an advanced age, typically starting at 80 or 85.
By allocating a portion of retirement savings to a QLAC, retirees can:
- Mitigate Longevity Risk: Ensure guaranteed income for life, even if other savings are depleted.
- Simplify Asset Management: Focus on managing a smaller pool of retirement assets during earlier retirement years.
QLACs are particularly appealing for individuals concerned about outliving their savings while seeking to reduce taxable income during the deferral period.
Retirement Accounts Eligible for QLAC Purchases
QLACs can be purchased using funds from the following types of retirement accounts:
- Traditional Individual Retirement Accounts (IRAs)
- 401(k) plans
- 403(b) plans
- Eligible governmental 457(b) plans
However, Roth IRAs cannot be used to purchase QLACs, as they do not have Required Minimum Distribution (RMD) requirements, and withdrawals from Roth accounts are generally tax-free.
Monetary Limits for QLAC Purchases
Congress has established specific limits on the amount of retirement savings that can be allocated to a QLAC:
- Initially, the limit was the lesser of 25% of the retirement account balance or $125,000, adjusted for inflation.
- In 2022, the limit was increased to $145,000.
- The SECURE 2.0 Act, effective December 29, 2022, introduced further flexibility:
- Repealed the 25% limit.
- Increased the maximum allocation to $200,000, indexed for inflation.
These updates aim to encourage greater adoption of QLACs by offering retirees more flexibility in planning for longevity income protection.
Key Requirements and Regulations for QLACs
Several regulations govern QLACs to ensure compliance and effectiveness:
- Contract Types: QLACs must be fixed annuities. Variable contracts, equity-indexed contracts, or similar products are not permitted.
- Death Benefits: QLACs may include death benefits, such as a return of premium to beneficiaries, equal to the difference between premiums paid and payments received. Spousal survival rights can also be included.
- Excess Premiums: If QLAC premiums exceed the allowed limits, the excess must be returned to the retirement account’s non-QLAC portion by the end of the following calendar year.
- Free-Look Periods: A free-look period of up to 90 days is allowed for contracts purchased or exchanged on or after July 2, 2014.
- Reporting: Form 1098-Q is required to report the status of QLACs held in defined contribution plans, IRAs, and eligible governmental plans.
The Pros and Cons of QLACs
Pros
1. Longevity Protection
QLACs provide guaranteed income for life starting at an advanced age, reducing the risk of outliving retirement savings.
2. RMD Reduction
Funds used to purchase a QLAC are excluded from the retirement account balance for RMD calculations, potentially lowering taxable income during the deferral period.
3. Tax Efficiency
By reducing RMDs, QLACs can lower Social Security benefit taxes, as Social Security income becomes taxable when combined income exceeds certain thresholds.
4. Simplified Asset Management
Allocating funds to a QLAC reduces the need to manage a portion of retirement assets, allowing retirees to focus on shorter-term planning for remaining savings.
5. Spousal Benefits
QLACs can provide spousal survival rights, ensuring income continuity for the surviving spouse.
Cons
1. Illiquidity
Funds used to purchase a QLAC are generally inaccessible until payments begin, limiting flexibility for unexpected expenses.
2. Inflation Risk
Most QLACs offer fixed payments that may not keep pace with inflation, reducing purchasing power over time.
3. Complexity
Understanding QLAC rules and regulations can be challenging, requiring careful planning and professional advice.
4. Opportunity Cost
Funds allocated to a QLAC are no longer available for other investments that may offer higher returns.
5. Premium Limits
Even with increased limits under the SECURE 2.0 Act, the caps may restrict high-net-worth individuals from fully utilizing QLACs for longevity protection.
Is a QLAC Right for You?
QLACs can be a valuable tool for retirees seeking a guaranteed income stream later in life. However, they may not suit everyone. Before incorporating a QLAC into your retirement plan, consider:
- Your liquidity needs for unforeseen expenses.
- The potential impact of inflation on fixed payments.
- Your overall retirement strategy and income goals.
For individuals with significant retirement savings, combining QLACs with other income-generating investments may provide a more balanced approach.
Conclusion
Qualified Longevity Annuity Contracts (QLACs) offer retirees a way to mitigate the risk of outliving their savings while reducing taxable income during earlier retirement years. By understanding the rules, limits, and benefits of QLACs, you can make informed decisions about whether they align with your retirement goals.
While QLACs have advantages such as longevity protection, RMD reduction, and tax efficiency, their drawbacks—like illiquidity and inflation risk—should be carefully weighed.
If you’re considering incorporating QLACs into your retirement strategy, consult a financial professional to determine whether they fit your unique needs.
For more information or assistance with QLACs, contact our office today!
