Recent Law Simplifies QLACs, Increases Their Benefits

The benefits of adding a qualified longevity annuity contract (QLAC) to your IRA were increased and made easier to take advantage of in a recent law.

A QLAC delays some required minimum distributions (RMDs) and generates guaranteed lifetime income after that, ensuring you never run out of income during retirement. Some people also consider them a way to fund any long-term care that’s needed later in life.

Through regulations issued in 2014, the IRS created QLACs as a special type of longevity annuity, also known as a deferred income annuity (DIA). Longevity annuities are relatively new themselves, with the first one being issued in the United States in 2004.

In a longevity annuity, an individual deposit money with an insurer. The insurer promises to pay the individual a fixed sum each month (or at some other interval) for the rest of his or her life.

The payments begin at a point in the future selected by the individual but no sooner than two years after the contract is entered into. The amount of the income payments is set when the contract is entered into.

In a QLAC transaction, the IRA deposits a lump sum with an insurer and receives the promise the insurer will pay a guaranteed lifetime stream in the future to the IRA or to the IRA owner.

As the IRA owner, you decide when the income payments will begin, within limits. Income payments from QLACs can start as early as age 72 or as late as 85. The income payments must be delayed for at least two years after the deposit and can be delayed for as many as 45 years or until the IRA owner reaches age 85, whichever is first.

The later the income payments begin, the higher they will be because you’ll be older, so the life expectancy will be less.

The QLAC 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.

An IRA can buy a regular longevity annuity that isn’t a QLAC. What makes the QLAC unique is that it reduces RMDs in the 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, because at the time RMDs had to begin after 70½.

In the 2014 regulations, the IRS established that the IRA balance deposited in the QLAC isn’t used to calculate RMDs through age 85 or until income payments begin. When income payments begin from the QLAC, the amount of the income is set to comply with the RMD rules.

As you know from past issues of Retirement Watch, RMDs are a major tax problem for many owners of traditional IRAs. RMDs must be taken whether the income is needed or not, and the life expectancy tables used to compute the RMDs cause a higher percentage of the IRA to be distributed each year.

The RMDs can increase income taxes, push the IRA owner into a higher tax bracket, and trigger or increase the Stealth Taxes, such as the taxes on Social Security benefits and the Medicare premium surtax.

Transferring part of a traditional IRA to a QLAC reduces RMDs in the years before the income payments begin and ensures that, once begun, the payments will last for life. The IRA owner knows the amount of the guaranteed lifetime income payments at the time the QLAC is entered into.

The SECURE Act 2.0 contained two important changes that make QLACs more attractive.

In the original regulations, the amount invested in QLACs couldn’t exceed the lesser of a total of $125,000 or 25% of the individual’s IRA balances. The $125,000 limit was indexed for inflation. The limits were per taxpayer, not per IRA.

The SECURE Act 2.0 first eliminated the 25% limit. Many people found it confusing to calculate, especially when they multiple IRAs.

In addition, the law increased the dollar limit to $200,000, indexed for inflation, beginning in 2023. The dollar limit still applies per person, not per IRA.

QLACs also can be purchased through 401(k)s and similar retirement plans that allow the transactions. The dollar limit applies per person across all retirement accounts.

If you want to defer a portion of your RMDs for a few years, consider putting a portion of your traditional IRA in a QLAC. It will have the additional benefit of guaranteed lifetime income.

One strategy is to buy a ladder of QLACs. 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 QLACs in different years. The future 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 after, when any need for long-term care (LTC) is likely to arise. The QLAC income, when coupled with Social Security, could be sufficient to pay for all or most of the LTC.

An added benefit is the QLAC income will be paid whether or not LTC is needed.

Another use of a QLAC is to restore the purchasing power of other income sources later in retirement.

A strategy for younger IRA owners is to buy QLACs 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 you’d receive by waiting to buy immediate annuities when you want the income to begin, according to calculations by Wade Pfau, a former professor at The American College and author of books and reports on retirement finances.

In the standard QLAC and deferred income annuity, the income payments end when the beneficiary passes away. If the beneficiary passes away before the income payments begin, there are no income payments.

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

You can add an inflation protection feature to a QLAC, so the income increases each year. Adding any of these features reduces the initial income you’ll receive compared to a QLAC without any of the features. 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 a one-time change to the date income begins. You also might be able to add money to the annuity, but a new income payout amount would 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 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 a guaranteed income later in life.