What Is a QLAC and Should It Be Part of Your Retirement Plan?
Everyone wants to live a long life, but no one wants to outlive their retirement savings. First authorized by the U.S. Treasury in 2014, qualified longevity annuity contracts (QLACs) provide a bridge between wanting to live forever and not wanting to die broke. Not only can QLACs provide guaranteed income — two words every retiree wants to hear — but they come with tax benefits, too. Here’s what you need to know.
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See: How Much You Should Have in Your Retirement Fund at Ages 30, 40, 50 and 60
Why Is It Called a Qualified Longevity Annuity Contract?
Breaking down the acronym makes the concept of a QLAC easier to understand. Forbes Advisor offers the following explanation:
- Qualified: This means that, when purchased with qualifying retirement account funds, a QLAC meets all the government’s requirements for special tax treatment.
- Longevity: This means that the contract is structured to ensure late-life payments, which can be delayed until the age of 85 even if you buy a QLAC now.
- Annuity contract: The term “annuity” covers a wide variety of financial and insurance products that provide regular payments for life.
The ‘Qualified’ Part Offers Versatility and Tax Advantages
Even if you’re new to QLACs, you’re probably familiar with the standard 401(k) plan. These employer-based plans shelter your money from taxes before you retire, but you must start making annual withdrawals — required minimum distributions (RMDs) — by age 72 and pay taxes on the money then.
That’s where QLACs can come in handy.
According to Fidelity, you can use a QLAC to defer distributions on some of the money in your 401(k) or IRA beyond the age of 72. That’s because you’re allowed to spend up to $135,000 of qualified retirement savings to buy QLACs. Not only is that money exempt from RMDs, but it doesn’t count as a taxable withdrawal and won’t be taxed until your annuity payments begin.
Fidelity gives an example of how it plays out in real life:
- A person buys a $135,000 QLAC at age 70, two years before RMDs kick in
- The person starts receiving yearly payments of $15,131 at age 80
- The person lives to age 95 after receiving $226,965 in total lifetime QLAC payouts
QLACs Also Provide Spousal Income
In review, QLACs can provide long-term, late-life income security. They can also defer RMDs from age 72 to 85, thereby reducing your required taxable 401(k) and IRA withdrawals. As a third benefit, they guard your principal against market volatility just when you need stability the most. But QLACs also come with one last upside.
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When opened jointly, QLACs continue to pay surviving spouses for the rest of their lives. Because of that, however, payments on joint QLACs are generally lower.
Consider the Limitations, Maximums and Exceptions
It’s important to note that $135,000 is the dollar limit, but you’re never allowed to transfer more than 25% of your retirement savings to a QLAC. To reach the $135,000 maximum, you’d have to have at least $540,000 in your 401(k) or IRA. If you have $400,000, your QLAC maximum would be $100,000.
It’s also important to note that while traditional IRAs do qualify for QLACs, Roth IRAs do not. According to Forbes, you can’t purchase QLACs with assets in Roth IRAs because Roth IRAs don’t come with RMDs. Inherited IRAs are also ineligible.
There Are Also a Few Downsides
One of the primary benefits of a QLAC — guarding the principal from the ups and downs of the market — can also be a drawback. By locking in growth at a fixed rate, according to Forbes, you forfeit what might have been higher growth with a more flexible investment vehicle. Perhaps most importantly, however, is that QLACs are not FDIC-insured the way other banking products are. The safety of your investment depends wholly on the financial health, management, insurance policies and solvency of the issuing company.
This article is part of GOBankingRates’ ‘Economy Explained’ series to help readers navigate the complexities of our financial system.
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Last updated: Aug. 25, 2021