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What Is a Qualified Longevity Annuity Contract (QLAC)?

what is qualified longevity annuity contract qlac

If you have spent some time exploring your options for retirement planning, you might have heard of a qualified longevity annuity contract, or QLAC for short. But what is a QLAC? What are some reasons that folks might consider this option for their situations?

As everyone knows, people tend to have many financial concerns nowadays. Having enough retirement income is a top concern among those who have stepped back from a full-time career. Among other things, low interest rates have made it harder to generate predictable income for even just run-of-the-mill living expenses in retirement.

With low rates hitting fixed-interest options such as CDs, Treasury securities, and bonds, the challenge is figuring out how to adequately supplement other sources of predictable income, such as Social Security or a pension. No wonder, then, that surveys have found that many retirees are afraid that they might run out of money in their later years.

Since they have a monopoly on paying reliable lifetime income, annuities are one vehicle that can help fill this gap. In fact, besides Social Security, annuities are the only thing on the planet capable of paying you a guaranteed income for life.

Challenges Still Linger

But even the income from an annuity may not be enough to cover a retiree's expenses when they get into their final years, especially if they need services such as long-term care or home healthcare.

Conversely, many retirees won’t need to start taking money from their IRAs or workplace retirement plans when they turn 72 (the new age at which required minimum distributions must start). RMDs can create a tax headache for those with considerable retirement assets, and they may be an excess source of income in some cases.

Enter again a possible solution with QLACs, which can help with providing income in later years or providing some tax relief for a while regarding required minimum distributions.

What Does a QLAC Do?

Qualified longevity annuity contracts are unique insofar as annuities go. This type of annuity differs fundamentally from traditional immediate or deferred annuity contracts. Whereas traditional annuities either grow in value or start paying a stream of income immediately, a QLAC doesn't start paying out until the contract holder turns 85.

Then the QLAC starts paying a high level of monthly income for the rest of its owner’s life. Therefore, QLACs can be beneficial to those who might need long-term care in their later years.

Another unique feature of QLACs is that they can allow someone to defer taking RMDs from them past their maximum retirement age.

How Do They Work?

QLACs are always fueled by qualified money (retirement accounts with pre-tax status), so the money sitting in one of these vehicles isn’t counted in RMD calculations by the IRS. This has been the case since Congress approved this exception in 2014.

For example, if a retiree has $400,000 in their 401(k) from their previous employer, then they could roll $100,000 into a QLAC and only have to take RMDs from the remaining $300,000. The money in the QLAC is excluded from the RMD calculation.

QLACs function effectively as "inverse" annuities, because instead of paying a smaller stream of income now, they pay a much larger stream of income later in the contract holder's life. Their feature of delaying required minimum distributions is another major advantage.

But QLACs can’t be started with any type of Roth money. Neither Roth IRAs nor Roth 401(k)s or other Roth employer retirement plans can be used toward a QLAC. Only traditional IRAs or qualified plan money can be used in these contracts.

An Important Distinction

The income paid by a QLAC is guaranteed. The income stream isn’t subject to market risk. But QLACs must meet certain requirements in order to maintain their tax-advantaged status.

One criterion that must be met is the maximum purchase amount that can be put into one of these contracts. Retirees can only contribute the lesser of $135,000 or 25% of their combined traditional IRA balances plus any QLAC balances that have already been bought as of December 31 of the year before the year in which the contract is purchased.

What Else Should You Keep in Mind?

Other important guidelines include:

- Your annuity payouts can be delayed only up to age 85. The IRS won't allow you to defer payments past this age.

- Income can be single life or joint life, but it can only be joint life with a spouse.

- Payout options are limited to life-only or life with cash refund, meaning your payout options are limited. If you chose the life-only option, then the insurance company would receive any remaining lump sum in your annuity if you were to pass away early.

- You can't buy a variable annuity or a fixed index annuity as part of your QLAC; only deferred income annuities are permitted.

- You may not purchase a QLAC with inherited IRA funds, including those from a parent.

- QLAC payments are fully taxable as ordinary income in the year in which they are received.

What Are the Pros and Cons of QLACs?

Here is a quick rundown of different advantages and disadvantages with a qualified longevity annuity contract.

Pros of QLACs

1. QLACs are relatively straightforward and don't have any fees.

2. They can help you reduce your RMD tax burden over your retirement.

3. Even though it's years in the future, the income you are told today that you will be paid is what you will receive.

4. The income won't change and is guaranteed.

Cons of QLACs

1. There is a limited amount of premium you can put into a QLAC, which limits your options for guaranteed income with this type of insurance contract.

2. There is a huge lack of liquidity compared to other fixed-type annuity contracts, which can let you withdraw up to 10% or sometimes more a year without any penalty. With a QLAC, your money is completely tied up in the contract. You can't take an early distribution from a QLAC for any reason.

3. With the life-only payout, if a policyholder passes away before they have been paid all of the contract value (money they put into the QLAC), the remaining balance would go to the insurance company.

4. Hence the life with cash refund may be a better option, but still limits your overall options for the guaranteed period of when you receive income.

QLACs Are Still Catching On

Even after being introduced in 2014, QLACs still haven't picked up with the American public. This has made it much harder for insurance companies to create and price competitive QLAC contracts compared to other annuity contracts out there.

For instance, several fixed index annuity contracts can be issued to contract holders while they are in their 80s. People might be interested in options such as these over QLACs because they can earn more interest or even pay more monthly income.

On the other hand, alternatives to QLACs include annuity laddering strategies that increase your income. A laddering strategy can include a fixed index annuity in early retirement and then a transfer into an immediate annuity for later retirement income.

What Might Make Sense for You?

Ask your financial professional about QLACs as well as alternative strategies that might make sense for you. QLACs are optimally designed for those who think that they will live well past age 85 and have limited income options for their retirement assets.

These contracts aren’t for everyone. But they do provide a sound alternative to other types of financial vehicles in some cases.

Of course, you might have questions about your financial picture that extend beyond this consideration. Will you have enough income for your entire retirement? Have you saved enough for a comfortable retirement lifestyle? Will you be able to spend what you want for your individual retirement goals? Are you confident in the plan that you already have?

If you are looking for someone to help you with these what-ifs, many independent financial professionals are available at SafeMoney.com. They can be of service to you and discuss your personal situation.

Use our "Find a Financial Professional" section to connect with someone directly. You can request an initial appointment to discuss your goals, concerns, and explore a working relationship. Should you need a personal referral, call us at 877.476.9723.

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