Episode Q - QLACs (Qualified Longevity Annuity Contracts)

What IS a QLAC? Why would someone want a QLAC? How would you go about getting one, if you decide it’s a great idea? What are the down sides of QLACs? 

QLACs, or Qualified Longevity Annuity Contracts, can be a really helpful addition to your retirement planning if you’re worried that your retirement savings might not last long enough, if you’re looking to minimize RMDs, or for a conservative investment that protects your money from market dips later in life. BUT QLACs aren’t free of downsides, and they definitely aren't right for everyone! 

Is a QLAC right for you? Take a listen, and if you want to hear more, give us a call!   

Transcript

EPISODE Q: QLACs

Welcome to Retirement A to Z, I’m Sue Burnett w Monarch Financial Advisors, and this series focuses on Qualified Retirement Plans. There are a lot of moving pieces with these plans, and the rules are complicated and complex, so we’re going to break them into smaller pieces – 26 pieces, to be exact, from A to Z, with maybe a few extras thrown in for good measure. 

This is Episode Q  – which will discuss QLACs, or Qualified Longevity Annuity Contracts. What IS a QLAC? Why would someone want a QLAC? How would you go about getting one, if you decide it’s a great idea? What are the down sides of QLACs? Let’s break it down.

First lets’ define what we mean by a QLAC – we’re going to go letter by letter.

The “Q” here means “qualified”, which means it’s met the requirements set by the government for special tax treatment, similar to a 401k and IRA. You don’t pay taxes on the money until you take it out of the QLAC; at that point, you pay ordinary income tax. You can’t purchase QLACs with the assets in a Roth IRA or an inherited IRA account. 

The “L” for Longevity is, of all the letters, I think the most important! It refers to the main purpose of a QLAC - making sure you don’t outlive your money, which is a big worry with many who are planning for retirement. You can buy the QLAC now and put off payments until as late as when you turn 85.

The A, for annuity, means the QLAC provides you with a guaranteed stream of income. The annuity is deferred, and can be started as late as age 85. 

Finally, the C is for contract – a QLAC is an annuity contract sold by insurance and financial services companies. When you buy a QLAC, you’re entering into a contract with the provider for the provider to pay you a set amount later in your lifetime. 

So put it all together, and you get QLAC – an annuity contract purchased from an insurance or financial services company, with qualified, or pre-tax dollars, guaranteeing a stream of income at a deferred age. The amount of the payments depends on the amount you’ve deposited in the annuity, the percentage growth they guarantee and the date you want to start receiving payments. The longer you wait to start receiving income, the larger your payments will be.

Why would you want a QLAC? Their primary purpose is to help prevent people from out living their retirement savings. In general people are living longer, and many fear that they’ll outlive their retirement savings. With a  QLAC, there will be a guaranteed income stream that kicks in later in life, helping to boost income down the road, and helping to avoid this fear. 

Another feature of a QLAC is that it helps reduce RMDs, or Required Minimum Distributions. With 401(k)s, 403(b)s, and most IRAs, by age 72, you have to begin withdrawing a minimum amount of money from the account every year and pay income tax on those withdrawals. These withdrawals are known as RMDs - Required Minimum Distributions. These RMDs are taxed at your ordinary income tax rate, and the amount of each year’s distribution is calculated by an IRS formula that takes into account your account balance, and your life expectancy.

QLACs aren’t subject to RMDs – which means that any money you put in a QLAC isn’t counted towards the RMD calculations - You’ll only start paying taxes on that amount when your annuity payments begin. So, if you’re looking to reduce your RMDs, contribute some of your retirement account to a QLAC – this will reduce the balance in your retirement account, which then reduces your RMDs.

For example, let’s say you have $400,000 in a traditional IRA when you turn 72. Your RMD that year would be $15,625. If you didn’t want or need that much, or you didn’t want to pay taxes on that amount, you could take some of that balance ad invest in a QLAC. What would happen if you took $100,000, and invested it in a QLAC? The QLAC has no required distributions until you turn 85, which is great. Your first RMD from your IRA will still be paid at age 72, but will now be based on $300,000, not $400,000, so your RMD decreases to $11,718. You receive about $3,900 less of a RMD, which means lower income taxes. The $100,000 you’ve spent on the QLAC won’t be taxed until you start receiving taxable annuity payments at a later date.

Can you invest all of your IRA into a QLAC? No - contributions to a QLAC are limited to the lesser of $135,000 or 25% of your qualified account balance. That means you can contribute up to $135,000 if you have over $540,000 of qualifying assets and up to 25% of total assets if you have less than $540,000. The $135,000 limit is a lifetime limit across all funding sources, although the cap may be adjusted periodically for inflation.

What if you have multiple qualified accounts? Those limits depend on what kinds of accounts they are. If you have 2 or more IRAs, the limit combines all of the balances when calculating the limit. If you have an IRA and a 401(k), you would have separate limits for each account, and the funding would be paid out of the separate accounts. 

When Should You Begin Collecting QLAC Income? That depends on your current age, health and  financial situation. The longer you defer the start date, the higher your payments will be. How long do you think you can live on the rest of your savings and income? How long do you think you’re going to live in general? If you’re 65 and in poor health, you probably don’t want to wait until age 85 to start receiving income payments—and, honestly, a QLAC may not be the right investment for you at all. But if you are healthy, and believe that you have a longer than average life expectancy, [QLACs] can be a windfall.

You may be able to change the payment date down the road, depending on the provider, but once payments start, it’s very unlikely that you can change any of the contract provisions. And remember, once payments start, those payments are taxable at your income tax rate in the year of payment. 

You may have the option to get a refund upon your death, if the QLAC hasn’t paid out at least the amount of premium you put in – the difference would be refunded to a beneficiary. Choosing this will lower the annual dollar value of QLAC payments you receive.

If you’re worried that your retirement savings might not last long enough, if you’re looking to minimize RMDs, or for a conservative investment that protects your money from market dips later in life, a QLAC may be a good option. 

BUT …. Does it sound too good to be true? Well, QLACs aren’t free of downsides. First, you’d be locking in your investment earnings at a low fixed rate, so you are giving up the chance of higher returns from other investments. The financial strength of the issuing company is also a concern. Annuities are not guaranteed by the FDIC or Federal Deposit Insurance Corporation (FDIC), like bank products – they’re guaranteed by the insurance company or financial services provider – and even though QLAC providers insure their products, it’s still possible for them to fall short. It’s really important to pay attention to the financial ratings of the insurer you’re purchasing the QLAC from – or, to spread the risk, you might also consider purchasing QLACs from more than one firm.

Wrapping it all up – QLACs can be a really helpful addition to your retirement planning if you’re worried about outliving your nest egg and if you like the idea of counting on a guaranteed income stream later in life. But the product certainly isn’t right for everyone. Is it right for you? Give us a call, and let’s check it out.  

Wanna learn more? Tune into the other a to z podcasts where we continue to break down these wonderful and complex plans into bite size pieces. Remember, how do you eat an elephant? 1 bite at a time. Have any questions? Shoot me an email at MonarchFinancialAdvisors@gmail.com. Thx for listening in and have a great rest of your day!