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A Little-Known Way To Supercharge Your IRA

Published on: Jul 10 2022

Many people could achieve a couple of retirement finance goals by adding a qualified longevity annuity contract (QLAC) to their IRAs.

Even if you never buy one, you should look at QLACs and know their advantages and disadvantages. (Qualified longevity annuity contracts were created in regulations issued by the IRS in 2014.)

They’re an IRS-approved way to secure a lifetime stream of income from your IRA, ensuring you never run out of income during retirement. They also can reduce required minimum distributions (RMDs) for several years during retirement.

Some people use them to fund long-term care that might be needed later in retirement.

First off, what is a qualified longevity annuity contract, exactly? It’s a special type of longevity annuity.

A longevity annuity, also called a deferred income annuity (DIA), is a relatively new type of annuity, first issued in 2004.

You deposit a lump sum with an insurer and receive a promise the insurer will pay a guaranteed lifetime stream in the future. You decide when the income payments will begin, within limits.

Income payments from qualified longevity annuity contracts can start as early as 72 or as late as 85. The income payments are delayed for as little as two years or as many as 45 years (but no later than to age 85) after you buy the annuity.

The later the income payments begin, the higher they will be.

The longevity annuity ensures you won’t run out of income during your lifetime. You’ll always have income from Social Security (the inflation-adjusted longevity annuity almost everyone has) and the longevity annuity.

A QLAC also reduces required minimum distributions in years before the income payments begin.

Until the 2014 regulations, it wasn’t clear how RMDs should be computed when a longevity annuity was purchased by an IRA.

To be safe, most insurers required income payments from a DIA to begin by age 70. The IRS resolved the issue in the 2014 regulations.

The IRA balance invested in QLACs isn’t used to calculate your required minimum distributions until income from the QLAC begins or you turn age 85, whichever occurs first. Required minimum distributions are a major problem for many traditional IRA owners.

The tax code forces them to take distributions each year after age 72, whether or not the income is needed. The distributions are calculated using life expectancy tables and are intended to drain the IRA over a person’s lifetime.

A higher percentage of the IRA is distributed as the owner ages. In the owner’s late 70s and beyond the RMDs often greatly exceed the income the owner needs.

The RMDs from a traditional IRA are included in gross income, so they create an income tax problem.

Under the 2014 regulations, the amount invested in QLACs isn’t used to calculate RMDs, up to a total of $125,000 invested or 25% of your IRA balance, whichever is less.

The $125,000 limit is indexed for inflation and is set at $145,000 for 2022. The $145,000 limit is calculated by aggregating all your IRAs.

In other words, it is a per taxpayer limit, not a per-IRA limit.

Whether you exceeded the 25% limit is determined by comparing the amount invested in QLACs to all your IRA balances at the end of the previous calendar year.

Married couples apply the limits per person.

Each spouse can invest up to $145,000 or 25% of his or her IRA in QLACs. Qualified longevity annuity contracts also can be purchased through participating 401(k) and similar plans and reduce RMDs the same way.

The 25% limit applies to each plan, and the $145,000 limit is per person.

Some IRA advisors recommend that you determine how much to invest in QLACs and move that amount to a separate IRA. This can make it easier to show you didn’t exceed the QLAC limits.

Many people would benefit from excluding up to 25% of their IRA balances from the RMD calculations, and they can do that for a period of time by buying QLACs with a portion of their IRAs.

One strategy is to buy a ladder of qualified longevity annuity contracts. Under a QLAC ladder, you buy several different QLACs with the income beginning in different years. That way, the guaranteed income increases over time.

You also can buy the QLACs in different years. The income payments will vary based on your age and interest rates in the years the QLACs were purchased. Some people use QLACs as a form of long-term-care insurance.

They buy the QLACs early in retirement with payments to begin in their late 70s or later, when any need for long-term care is likely to arise. The QLAC income when coupled with Social Security makes it likely they’ll have enough income to pay for any long-term care.

If the care isn’t needed, the QLAC income ensures they’ll never run out of money regardless of what happens with their investment portfolios. The QLAC income also supplements other income sources, restoring purchasing power lost to inflation.

A strategy for younger IRA owners is to buy DIAs while in their 50s and schedule income payments to begin between ages 65 to 70, or whenever they plan to retire.

This can generate more guaranteed lifetime income than waiting to buy an immediate annuity when you want the income to begin, according to calculations by Wade Pfau, a professor at The American College.

A QLAC doesn’t have to be a use-it or lose-it asset.

Most people believe you and loved ones don’t receive anything if you don’t live to the age when income distributions begin.

But qualified longevity annuity contracts are more flexible. You can set up the QLAC to pay income to both you and your spouse until you both pass away, though your spouse didn’t contribute to your IRA.

You also can set the QLAC to provide some income or a return of premiums to a beneficiary if you pass away prematurely. The amount of income from a QLAC is set and guaranteed when you buy the annuity, but you can add an inflation protection feature.

Keep in mind that adding any of these features reduces the income you’ll receive compared to a QLAC without any of them. Request quotes with and without the features to determine which option makes the most sense for you.

Once a QLAC is purchased, limited changes are allowed.

Most insurers allow you to change to the date income begins one time.

You also might be able to add money to the annuity, but a new income payout amount will be calculated for that contribution.

Not all longevity annuities are QLACs.

Your IRA can own a longevity annuity that isn’t a QLAC, but it won’t help reduce the RMDs.

Any annuities issued before July 2, 2014, the effective date of the IRS regulations, aren’t QLACs.

Not all longevity annuities issued after that date are QLACs. Be sure the insurer verifies an annuity is a QLAC and not a standard longevity annuity.

Variable annuities, indexed annuities and other types of annuities also aren’t QLACs. You can’t own a QLAC in a Roth IRA.

You might want to own a regular longevity annuity in a Roth IRA to provide guaranteed income later in life. (We have a wealth of information on annuities behind the firewall on RetirementWatch.com, so I encourage you to become a full-fledged member today, by going to this link.

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