Key Takeaways
- Deferred annuity from tax-qualified retirement accounts.
- Starts lifetime income payments by age 85.
- Reduces required minimum distributions and taxes.
- Protects against outliving retirement savings.
What is Qualified Longevity Annuity Contract (QLAC)?
A Qualified Longevity Annuity Contract (QLAC) is a deferred income annuity purchased within a tax-qualified retirement account such as a traditional IRA or 401(k). It is designed to provide guaranteed lifetime income starting no later than age 85 while allowing you to defer required minimum distributions (RMDs), reducing taxable income during early retirement years.
QLACs help manage longevity risk by ensuring income later in life without market exposure after purchase, making them a strategic tool in retirement planning and taxation management.
Key Characteristics
QLACs have distinct features governed by IRS rules that affect their use and benefits:
- Funding Source: Purchased with funds from tax-qualified plans excluding Roth IRAs, such as traditional IRAs or 401(k)s.
- Payment Start Age: Income payments must begin by the first day of the month after age 85, though earlier payouts are optional.
- Premium Limits: Dollar cap applies to premiums (indexed annually), with percentage limits repealed after 2022 changes.
- RMD Exclusion: The QLAC amount is excluded from your retirement account balance for RMD calculations until payments begin or age 85.
- Death Benefits: Optional death benefits return premiums minus payouts to beneficiaries under specific IRS rules.
How It Works
You purchase a QLAC using funds from your IRA or 401(k), transferring assets to the insurer without triggering immediate taxation. The value used for the QLAC is then excluded from your account balance when calculating RMDs, potentially lowering your taxable income during your early 70s and 80s.
When you reach the chosen start age (no later than 85), the annuity begins paying a guaranteed lifetime income. These payments are taxed as ordinary income, similar to other qualified distributions. This arrangement can reduce your overall tax burden and help stabilize your income in later retirement years, complementing other investments like low-cost index funds.
Examples and Use Cases
QLACs are well-suited for retirees seeking predictable income streams and tax deferral strategies. Common examples include:
- Longevity Planning: Individuals with a family history of long lifespans use QLACs to ensure income after traditional savings may be depleted.
- Tax Management: Delaying RMDs with a QLAC can reduce taxable income early in retirement, potentially lowering Social Security taxation and Medicare premiums.
- Corporate Pension Supplement: Employees of large companies like Delta may integrate QLACs with their retirement portfolios to enhance income security.
- Portfolio Diversification: Combining QLACs with other assets, such as monthly dividend stocks or bonds, helps balance income risk and market volatility.
Important Considerations
While QLACs offer valuable benefits, you should weigh limitations like illiquidity and lack of inflation adjustment. Once purchased, accessing principal is generally not possible without penalties, and payments do not increase to keep pace with inflation.
Additionally, selecting a financially strong insurer is critical for long-term guarantees. Staying informed on evolving IRS rules, including recent premium cap changes, ensures compliance and maximizes benefits. For a deeper understanding of investment returns related to annuities, consider reviewing the rate of return concepts.
Final Words
A Qualified Longevity Annuity Contract (QLAC) can effectively reduce your required minimum distributions and secure guaranteed income late in retirement. Assess your current retirement savings and consult a financial advisor to determine if adding a QLAC fits your long-term income strategy.
Frequently Asked Questions
A QLAC is a deferred income annuity purchased using funds from a tax-qualified retirement account like a traditional IRA or 401(k). It provides guaranteed lifetime income starting no later than age 85 and helps delay required minimum distributions (RMDs).
The amount invested in a QLAC is excluded from your retirement account balance when calculating RMDs, which begin at age 73 or 75 depending on your birth year. This exclusion can lower your current RMDs and potentially reduce your taxable income and Medicare premiums.
As of December 29, 2022, the IRS removed the percentage limit on QLAC premiums, leaving only a dollar cap that is adjusted annually, which was previously $145,000. Before that date, premiums were limited to the lesser of 25% of your account balance or the dollar cap.
You can purchase a QLAC inside a traditional IRA or a qualified defined contribution plan like a 401(k), but not inside a Roth IRA. The contract must follow strict IRS rules to qualify for special tax treatment.
QLAC payments must begin no later than the first day of the month after you turn age 85, but you can choose to start receiving income payments earlier if you prefer.
Income payments from a QLAC are taxed as ordinary income when received, similar to other qualified annuity distributions. The taxation uses an exclusion ratio that spreads the return of principal and taxable income over time.
Yes, QLACs help protect against longevity risk by providing guaranteed lifetime income starting later in life, ensuring you don’t outlive your retirement savings without exposure to market fluctuations after purchase.
If death benefits are elected, the beneficiary may receive the return of premium minus any payouts already made, subject to specific IRS rules. These payouts are generally taxed as ordinary income if annuitized.
