Could a Qualified Longevity Annuity Contract Be a Good Choice?

Back in 2014, the U.S. Treasury Department issued a rule creating qualified longevity annuity contracts (QLACs), which is considered a deferred income annuity (DIA) that are designed to start payments for investors at a later date. So, in exchange for a lump sum now, say when an investor is 65, an insurance company would start paying out monthly checks when the investor turns 80. This is different from an immediate annuity that starts paying income right away.

QLACs are unique in that they use so-called ‘qualified funds.’ These are assets that investors have not paid taxes on yet. These are your traditional IRAs, employer-sponsored retirement plans like 410ks, 403bs, and 457 plans. So, investors can take a portion of their 401k, invest it in a QLAC today, and start receiving income at a later period in their lives.

Why do this? Well, the advantages of using a QLAC are actually pretty good for many investors.

For starters, the longer the deferral period, the greater the income potential. Income payments from QLACs can start as early as 72 or as late as 85. Waiting till 85 provides a higher payout for retirees just when they might need it the most. Moreover, they tend to provide more income for initial investment than buying immediate annuity later in life. According to Fidelity, a 72-year-old who invests $135,000 into a QLAC would get a monthly payment of about $2,200 starting at age 80. An immediate annuity purchased at 80 would only generate about half as much income.

QLACs also allow investors to take advantage of taking social security earlier. The longer you wait, the larger your social security benefits are. A QLAC can eliminate the need to wait on social security. By knowing an investor will get a ‘boost’ to their income later in life, they can freely take social security benefits now.

Perhaps the biggest win for QLACs comes down to deferring taxes and reducing the dreaded required minimum distributions (RMDs). Unfortunately, Uncle Sam will not let you defer taxes forever on your investments in your IRA or 401(k). After investors hit age 72—70 ½ if you reach 70 ½ before January 1, 2020—the government requires that you withdraw a certain amount every year and, in turn, pay taxes on those withdrawals. These RMDs can be a hassle.

However, when an investor buys a QLAC, the amount purchased is removed from the RMD calculation. This allows investors to save on taxes today and push more of their savings into the future with tax deferral. The best part is that this deferral tends to reduce overall long-term tax costs.

Given their benefits, it’s easy to see why many market pundits and policymakers are turning their attention to QLACs in retirement plans as a way to help stem the longevity crisis. Both the House and Senate are still hammering out the details of the so-called SECURE Act 2.0. The sequel to the wide-sweeping retirement legislation features plenty of love for QLAC in both versions of the bill.

One issue with QLACs is that there is a cap on how much you can place in the investment vehicle. This was designed to prevent the very wealthy from reducing RMDs by too much and avoiding the payment of taxes. Right now, investors can put a maximum of $135,000 or 25% of the value of their retirement accounts, whichever is less, into a QLAC. That $135k is the maximum per person in total, not per account.

The Senate’s proposal is to raise the maximum investment to $200,000 and remove the 25% limit on value. The House’s bill would remove the 25% of value cap. By eliminating the cap, smaller investors would be able to buy more income when they need it.

Additionally, both bills would make it easier for retirement plans to offer QLACs as an investment choice directly. Thanks to arcane rules that put retirement plan sponsors at risk when they offer annuities, only about 3% of plans have QLACs as an option. Right now, investors need to do a ‘song & dance,’ roll-over the assets from a 401k to an IRA that offers DIAs, and then purchase.

With both bills having plenty of legislation about QLACs, it’s assured that investors will be hearing and seeing more about these products in the near future.

Don’t forget to check out this article to learn how the SECURE Act can impact annuities.

Given the benefits of fighting longevity and the ability to reduce RMDs, qualified longevity annuities could make a lot of sense for many investors. While there are some risks of not living long enough, the rewards could make it worth it for many investors. And with Congress getting on board, QLACs could be a wonderful future financial planning tool for many investors.

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