What Is a Qualified Longevity Annuity Contract (QLAC)?

A qualified longevity annuity contract (QLAC) is a type of deferred annuity funded with an investment from a qualified retirement plan or IRA. QLACs provide guaranteed monthly payments until death and are shielded from the downturns of the stock market. As long as the annuity complies with Internal Revenue Service (IRS) requirements, it is exempt from the required minimum distribution (RMD) rules until payouts begin after the specified annuity starting date.

Key Takeaways

  • A QLAC is a retirement strategy in which a portion of the required minimum distributions (RMD) is deferred until a certain age (maximum limit is 85). The insurer takes on market and interest rate risk.
  • Under current rules, an individual can spend 25% or $135,000 (whichever is less) of their retirement savings account or IRA to buy a QLAC.
  • The main benefit of QLAC is a deferral of taxes that accompanies RMDs.

What Is An Annuity?

Understanding Qualified Longevity Annuity Contracts

One of the biggest fears many people have as they grow older is outliving their money. Qualified Longevity Annuity Contracts are a creation of the IRS to address this issue. The QLAC is an investment vehicle that guarantees that funds in a qualified retirement plan, such as a 401(k), 403(b) or IRA, can be turned into lifetime income without violating required minimum distribution rules for those turning age 72. QLACs allow a spouse or someone else to be a joint annuitant, meaning that both named individuals are covered regardless of how long they live (with some conditions).

In effect, QLACs act as longevity insurance. As such, they are a valuable tool in retirement income planning. Under 2020 contribution limits, an individual can spend 25% or $135,000 (whichever is less) of their retirement savings account or IRA to buy a QLAC via a single premium. The longer an individual lives, the longer a QLAC pays out. QLAC income may be deferred until age 85.

Qualified Longevity Annuity Contract and Taxes

QLACs have the added benefit of reducing a person's required minimum distributions, which IRAs and qualified retirement plans are still subject to even if an individual does not need the money. This can help keep a retiree in a lower tax bracket, which has the added benefit helping them avoid a higher Medicare premium.

Once a retiree's QLAC income begins flowing, it could increase their tax liability. However, if managed correctly any additional tax liability can be minimized if other taxable retirement savings income sources are spent down first.

The promised benefit of QLACs can only be achieved if rules set by the IRS are followed. The annual distribution is based on the value of the account at the end of the preceding year.

Qualified Longevity Annuity Contract Considerations

One option for getting the most out of QLACs is by laddering them, meaning buying several smaller contracts (in the $25,000 range, for example) over several years. Such a strategy is like dollar-cost averaging, which makes sense given that annuity costs can fluctuate along with interest rates.

QLAC buyers are often given the option of adding a cost of living adjustment to their contract, which indexes the annuity against inflation. Deciding on this depends on life expectancy, since the cost of living adjustment will reduce the QLAC's initial payout.

The biggest risk of buying a QLAC is the financial strength of the issuing company. If they go bankrupt the QLAC may not be enforceable. QLAC buyers should consider buying more than one from different issuers to limit their risk.

Example of QLAC

Take Shahana, who is 67 and due to retire in three years. She would like to save on tax liabilities from her RMDs. Based on her current retirement account balances, she is due to receive $7,000 RMD monthly from her IRA account, once she reaches 70.5 years.

But Shahana has other plans. She has made investments in other assets, such as stocks and bonds and real estate, which should provide her with an income stream post-retirement. Besides this, she plans to consult on a part-time basis to stay current in her field and earn extra cash. All in all, she expects to lead a lifestyle that is comfortable and not lavish, post-retirement.

To make adequate preparations for her old age, she invests $100,000 in a single premium QLAC account from her IRA savings account that she plans to withdraw when she turns 85. This will set back her RMD withdrawal date by 18 years but it will add $10,000 to the amount she collects.