A QLAC is a delayed fixed annuity contract purchased using money from a retirement account, such as a 401(k) or an individual retirement account, sold by insurance and financial services organizations (IRA).
What is a QLAC and how does it work?
- A qualified long-term annuity contract (QLAC) is a retirement strategy in which a percentage of required minimum payments (RMDs) is postponed until a certain age (maximum limit is 85). Market and interest rate risk are taken on by the insurer.
- A person can buy a QLAC using 25% of their retirement savings account or IRA, or $135,000 (whichever is less) under current laws.
What is the maximum limit for funding a QLAC in 2020?
Effective January 1, 2020, the QLAC ceiling (highest amount you can convert) has increased to $135,000, up from $130,000 in 2018 and $125,000 when the QLAC was formed in 2014.
How much does a QLAC cost?
You can start a QLAC with as little as $5,000 and add to it over time with various policies. You can also buy the complete QLAC in one go and divide the cost across multiple insurers. Purchases of QLACs are limited to either 25% of your IRA portfolio or $130,000.
At what age can you buy a QLAC?
A QLAC is a DIA that can only be funded with assets from a standard IRA4 or a qualified employer-sponsored plan like a 401(k), 403(b), or governmental 457. (b). You can choose an income start date up to age 85 at the time of purchase, and the amount you invest in a QLAC is deducted from future RMD calculations.
“The QLAC has opened up the potential to postpone income past 72, the RMD start age, by using tax-deferred investments like an IRA or 401(k),” says Tom Ewanich, vice president and actuary at Fidelity Investments Life Insurance Company.
QLACs address one of the most common worries among retirees: ensuring that their investments do not outlive them. After all, according to the Employee Benefit Research Institute’s 2020 Retirement Confidence Survey, three out of every four retirees and workers feel income stability is more essential than protecting account balances or sustaining wealth in retirement.
A QLAC provides a guaranteed5 stream of income for the rest of your life, starting on the date you choose. For example, you may buy a QLAC at 65 and start receiving payments at 75. When you’re ready to start receiving income installments, the longer the deferral period, the greater your payout will be.
Funding a DIA with eligible funds from an IRA was difficult until the 2014 rule on QLACs: RMD laws in IRAs and other tax-deferred plans like 401(k)s mandate you to start taking withdrawals when you reach the age of 72. However, there are limits to how much money you may put into a QLAC. There are two restrictions in place right now: Total lifetime contributions from all funding sources cannot exceed $135,000, and QLAC contributions from any one funding source cannot exceed 25% of that funding source’s value. 6
Are QLAC a good idea?
If you’re worried about outliving your money, a QLAC could be a good addition to your retirement plan. Guaranteed payouts that begin in your 80s can provide peace of mind today while also providing substantial money in the future.
However, given the lifetime cap on what you can move into a QLAC, purchasing a QLAC to decrease your RMDs is unlikely to be a major victory. And you’re not lowering your tax bill forever; you’re just deferring it till you’re 85.
Charitable distributions and Roth conversions may be more effective alternatives to consider if your goal is to manage taxes in retirement.
Are QLAC a good investment?
For retirees, a QLAC has various advantages: Long-term financial stability. A QLAC might provide you peace of mind if you’re anxious that your retirement savings won’t last the long haul. QLACs provide guaranteed income in retirement and can be used to offset the costs of long-term care later in life.
How are Qlacs taxed?
Annuities are taxed differently depending on whether they were purchased with pre-tax or post-tax funds. The percentage of any income payments that comprises a return of that premium will not be taxable if the premium was paid with after-tax money, as with a non-qualified annuity. This isn’t true for QLACs, which are qualified annuities bought with pre-tax retirement funds. All annuity distributions will be fully taxable at regular income tax rates because the money used to fund the annuity was never taxed.
For detailed information on annuity taxation as it applies to your specific situation, you should see a tax professional. Each phase of the QLAC contract and the tax treatment associated with it can be summarized as follows:
Pre-tax money will be transferred from one form of qualified retirement account to another at the time of purchase. Because traditional IRAs, 401(k)s, and QLACs all have the same tax status, moving money between them is tax-free.
Deferral: During the deferral period, no taxes are due. Because there is no accumulating account value in QLACs, there is nothing to tax. In fact, no taxes would be due even if the account value accrued interest (as with a fixed annuity) or earned capital gains (as with a variable annuity). Annuities, as retirement savings vehicles, can grow tax-deferred.
Annuitization: When the QLAC is annuitized, that is, when income payments start, taxes are due. Each annuity distribution will be taxed as regular income in accordance with your tax bracket. Your insurance company will use tax form 1099-R to report these taxable distributions to you and the IRS.
Death Benefit: In the event of the annuitant’s premature death, beneficiaries will receive any remaining value in the contract, which is equal to the difference between the initial premium paid and the cumulative income payments received, for QLACs with a Refund at Death (a.k.a. return of premium and/or death benefit riders). Any death benefit owed to the recipient will be paid straight to them, bypassing the probate process. Instead of receiving the death benefit in one lump payment, the recipient can choose to annuitize it throughout the rest of his or her life. In any case, the annuity contract will usually be included in the deceased’s estate, and any proceeds will be taxed at regular income tax rates to the beneficiary.
Will I be required to take RMD in 2021?
This year, don’t forget to take required minimum distributions from your retirement accounts. RMDs the amounts you must take each year from most retirement accounts once you reach a particular age were waived for 2020, but they are back in effect for 2021.
Can you lose your money in an annuity?
Variable annuities and index-linked annuities both have the potential to lose money to their owners. An instant annuity, fixed annuity, fixed index annuity, deferred income annuity, long-term care annuity, or Medicaid annuity, on the other hand, cannot lose money.
How can I reduce my RMD tax?
- RMDs are not required for all retirees who have reached the age of 72 and have a standard 401(k) or IRA.
- There are several ways to decrease or perhaps avoid the tax liability associated with RMDs.
- Delaying retirement, converting to a Roth IRA, and reducing the number of initial distributions are all options.
- RMDs can also be donated to a qualified charity by traditional IRA account holders.
How do I invest in RMDs I don’t need?
If you don’t need the RMD, put it in a taxable account or, if you’re eligible, a Roth IRA or conventional IRA. These strategies can go a long way toward growing wealth for folks who have inherited IRAs and are taking RMDs.