A qualified longevity annuity contract, or QLAC is an annuity you purchase from an insurance company using money (from your IRA or other qualified retirement plan such as a 401(k). A QLAC provides guaranteed monthly payments until death and avoids the volatility in the stock market. So long as the QLAC follows the IRS rules, it is exempt from the Required Minimum Distribution (RMD) rules until income stream begins. Purchasing a QLAC lowers your RMD’s which must begin at age 72 and reduces your tax bill in the years prior to the commencement of annuity payments from the QLAC.
The QLAC makes guaranteed monthly payments at a later age. The longer you live, the longer the payments go on for. You cannot outlive the income stream. A QLAC is longevity insurance and can be a valuable tool in retirement income planning.
A qualified longevity annuity contract is designed to prevent you from outliving your retirement savings. The term longevity in the name is key: QLACs are deferred annuities that you can buy at any time, with payments that commence later during your retirement years. The latest you can start annuity payments from a QLAC is age 85. Typically, the longer the deferral period, the higher your payout will be when you're ready to start receiving income payments.
While a QLAC delays taxable distributions, it does not eliminate them. Once your QLAC income commences, it could increase your tax liability. However, if managed correctly, any additional tax liability can be minimized if other taxable retirement savings income sources are spent down first. This requires a lot of planning and coordinating to get it right and working with a financial professional can add some value in being more effective with your retirement income distributions.
You are allowed to use up to 25% of your IRA or qualified retirement account to purchase a Qualified Longevity Annuity Contract up to a combined maximum of $145,000. Since this portion of your portfolio enables you to delay RMD’s, your initial tax liability will be reduced until the QLAC payments commence later.
Inherited IRA’s cannot be used to purchase QLACs.
How Does a QLAC Lower your Tax bill?
Every dollar you withdraw from your Traditional IRA or 401(k) is taxed as ordinary income, which can add up to a large tax bill if you have a well-funded retirement. That’s why some recommend purchasing a QLAC to help reduce RMDs and related taxes in the early years of your retirement.
At age 72, the IRS mandates that you start taking money out of your traditional IRA and 401(k) accounts. The RMD is a percentage of your account that you must withdraw, and it’s based on your age. At age 72, the RMD is 3.65% of the balance on December 31 of the year before. Your RMD percentage rises each year as you age. By age 90 it’s nearly 9% of the account value each year.
Lower RMD’s can help reduce your income tax bill and they can help you avoid the net investment income tax of 3.8% for high income taxpayers.
There are other benefits as well. Your Medicare part B premium increases as your AGI gets larger. For higher income households, the Medicare IRMAA premium can be nearly $600 per month.
The biggest risk of buying a QLAC is the financial strength of the issuing insurance company. If it goes bankrupt, the QLAC may not be able to make some or all of the annuity payments at the specified age. You may want to consider buying more than one from different issuers to limit their risk.
Fighting the effects of inflation using QLACS
Some QLACs have inflation protection built into the annuity contract. Pacific Life, Lincoln Financial, & American General are among QLAC issuers that have this feature. You can also ladder QLAC purchases over time. Knowing there is a lifetime purchase maximum of $145,000 you could purchase QLAC’s for $50,000, $50,000 and $45,000 every three years from age 65 to 71, each time increasing the longevity protection.
When should you collect income from a QLAC?
Choosing a start date for QLAC income payments depends on many factors such as your current age, health condition and financial situation. The longer you defer the start date, the higher your payments will be.
One important factor to consider is your life expectancy and longevity. The longer you live, the more you get paid. The shorter your life expectancy, the less you will receive. That’s why you may want to choose a joint life QLAC where the payments do not stop until you and your spouse die.
What is a Cash Refund Feature?
Some QLACs will offer the option to pay a refund upon your death. If there’s any difference between the premium you paid for the plan and the sum of all payments made from the plan, it will be refunded to your beneficiary.
Keep in mind that choosing a refund death benefit or joint life QLAC will lower the annual dollar value of QLAC payments you receive.
QLACs are a great way to protect yourself and your portfolio from running out of money later in retirement. They ensure a guaranteed income stream later in life that you cannot outlive. By deferring the income stream, you reduce your tax liability earlier on in retirement. There are many features and benefits of the QLAC that you need to familiarize yourself with in order to make the choice that’s right for you.
If you have questions or would like to discuss this further, please do not hesitate to contact the office.
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