Many people could achieve a couple of retirement finance goals by adding a qualified longevity annuity contract (QLAC) to their IRAs.
QLACs 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. Some people use them to fund long-term care that might be needed later in retirement.
In a QLAC, 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 QLACs 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 RMDs in years before the income payments begin. Regulations issued in 2014 say the IRA balance invested in QLACs isn’t used to calculate your RMDs until income from the QLAC begins or you turn age 85, whichever occurs first. The amount that can be invested in QLACs and not be used to calculate RMDs is limited to $125,000 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.
QLACs 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.
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 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 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 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.
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.