Qualified Longevity Annuity Contract

MoneyBestPal Team
By : personMoneyBestPal Team
March 14, 2023
A special type of deferred annuity that allows you to use a portion of your retirement savings to buy a guaranteed income stream for life.
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Main Findings

  • QLAC is a type of deferred annuity that can help you reduce your RMDs, defer taxes, and guarantee income for life.
  • QLAC can be a useful tool for retirement planning, especially if you are concerned about outliving your savings or want to diversify your income sources.


A Qualified Longevity Annuity Contract (QLAC) is a special type of deferred annuity that allows you to use a portion of your retirement savings to buy a guaranteed income stream for life, starting at a later age.


A QLAC can help you reduce your required minimum distributions (RMDs) from your retirement account, defer taxes on your savings, and protect you from outliving your money.



Why buy a QLAC?

A QLAC can be a useful retirement planning tool for several reasons:


QLAC can lower your RMDs and taxes.

By investing some of your retirement savings in a QLAC, you can exclude that amount from your RMD calculations until you start receiving payments from the QLAC. This can reduce your taxable income and keep you in a lower tax bracket.


QLAC can provide lifetime income.

A QLAC can guarantee you a steady income for as long as you live, regardless of market fluctuations or economic conditions. This can help you cover your essential expenses and avoid running out of money in retirement.


QLAC can hedge against longevity risk.

A QLAC can help you plan for a long-life expectancy and protect you from the risk of outliving your savings. By delaying the start of your QLAC payments, you can increase the amount of income you receive and create a buffer against inflation and rising healthcare costs.



The formula for QLAC payments

The amount of income you receive from a QLAC depends on several factors, such as:

  • The premium amount. This is the amount of money you invest in the QLAC, which is subject to certain limits (see below).
  • The interest rate. This is the rate of return that the insurance company guarantees on your premium, which is locked in at the time of purchase.
  • The payout start date. This is the date when you begin receiving income from the QLAC, which can be anytime between age 70 1/2 and 85.
  • The payout frequency. This is how often you receive income from the QLAC, which can be monthly, quarterly, semiannually, or annually.
  • The payout option. This is the type of annuity contract that determines how long you receive income from the QLAC and whether it continues to your beneficiaries after your death.


There are several payout options available, such as:


Life only.

This option pays you income for as long as you live but stops when you die. It provides the highest amount of income, but no death benefit.


Life with a cash refund.

This option pays you income for as long as you live and returns any remaining premium to your beneficiaries if you die before receiving it all back. It provides a lower amount of income than life only but guarantees that your premium will not be lost.


Life with period certain.

This option pays you income for as long as you live and continues to pay your beneficiaries for a fixed number of years (such as 10 or 20) if you die before the end of that period. It provides a lower amount of income than life only but ensures that your payments will last for at least a minimum duration.


Joint and survivor.

This option pays you income for as long as you live and continues to pay your spouse or another person for as long as they live after your death. It provides the lowest amount of income but covers two lives instead of one.



The formula for calculating the QLAC payments is:


QLAC payment = (Premium x Interest rate) / Annuity factor


The annuity factor is a number that reflects the payout option, the payout frequency, and the life expectancy of the annuitant(s). It is determined by the insurance company using actuarial tables and assumptions.



How to calculate QLAC payments

To calculate how much income you can expect from a QLAC, you need to know the premium amount, the interest rate, the payout start date, the payout frequency, and the payout option. You also need to find out the annuity factor from the insurance company or use an online calculator.


For example, suppose you are 65 years old and want to buy a QLAC with $100,000 from your IRA. You want to start receiving payments at age 80, every month, with a life-only payout option. You find an insurance company that offers a 3% interest rate and an annuity factor of 15.6 for this scenario.


Using the formula above, you can calculate your QLAC payment as follows:


QLAC payment = ($100,000 x 0.03) / 15.6

QLAC payment = $3,000 / 15.6

QLAC payment = $192.31 per month


This means that you will receive $192.31 every month for the rest of your life, starting at age 80, from your QLAC. Note that this amount is fixed and does not adjust for inflation or cost-of-living increases.



Examples

To illustrate how a QLAC works, let's look at some hypothetical examples.


Example 1

Bob is 65 years old and has $500,000 in his IRA. He wants to buy a QLAC to reduce his RMDs and secure income for life. He decides to invest $100,000 in a QLAC that will start paying him $12,000 per year when he turns 80.


By doing so, he lowers his RMDs by $3,650 in the first year (assuming a 3.65% distribution factor) and by more than $100,000 over his lifetime (assuming he lives until 95). He also receives a guaranteed income of $12,000 per year for as long as he lives after age 80, regardless of market conditions or interest rates.



Example 2

Alice is 70 years old and has $400,000 in her 401(k). She wants to buy a QLAC to supplement her Social Security income and hedge against longevity risk. She decides to invest $50,000 in a QLAC that will start paying her $8,000 per year when she turns 85.


By doing so, she lowers her RMDs by $1,825 in the first year (assuming a 3.65% distribution factor) and by more than $50,000 over her lifetime (assuming she lives until 95). She also receives a guaranteed income of $8,000 per year for as long as she lives after age 85, which can help cover her medical expenses or other needs.



Limitations

While a QLAC can offer many benefits, it also has some limitations that you should be aware of before buying one.


A QLAC is not liquid.

Once you buy a QLAC, you cannot withdraw your money or cancel your contract. You have to wait until your annuity start date to receive any payments. If you die before your annuity start date, your beneficiary may receive a death benefit equal to your premium or less, depending on the contract terms.


A QLAC is not inflation-adjusted.

Unless you buy a QLAC with a cost-of-living adjustment (COLA) feature, which will increase your payments by a certain percentage each year, your payments will remain fixed and may lose purchasing power over time due to inflation.


A QLAC is subject to IRS rules and limits.

You can only buy a QLAC with up to $200,000 or 25% of your retirement account balance, whichever is less. You also cannot defer your payments beyond age 85. If you violate these rules, your QLAC may lose its tax benefits and be subject to penalties.


A QLAC is not guaranteed by the federal government.

Unlike FDIC-insured bank accounts or Treasury bonds, a QLAC is not backed by the full faith and credit of the U.S. government. Your payments depend on the financial strength and claims-paying ability of the insurance company that sells you the QLAC. If the insurance company fails, you may lose some or all of your money.



Conclusion

A QLAC is a type of deferred annuity that can help you reduce your RMDs, defer taxes, and guarantee income for life. It can be a useful tool for retirement planning, especially if you are concerned about outliving your savings or want to diversify your income sources.


However, a QLAC also has some drawbacks, such as illiquidity, inflation risk, IRS restrictions, and credit risk. Therefore, you should carefully weigh the pros and cons of a QLAC before buying one and consult with a financial professional if you have any questions.



References


FAQ

A QLAC is a type of annuity that allows the owner to defer a portion of their required minimum distributions (RMDs) from their retirement accounts until a later age, up to 85. This can provide a steady stream of income later in retirement.

Unlike traditional annuities, QLACs are specifically designed to start payouts later in life, providing a form of longevity insurance. Also, the money invested in a QLAC is not considered in calculating RMDs.

QLACs can provide a guaranteed income stream later in life, which can be beneficial for individuals who are concerned about outliving their savings. They also offer tax advantages by allowing individuals to defer a portion of their RMDs.

Yes, there are limitations on how much you can invest in a QLAC - currently, the lesser of $135,000 or 25% of your retirement account balance. Also, like all annuities, QLACs are subject to the claims-paying ability of the issuing insurance company.

While QLACs can be a good fit for individuals who are concerned about longevity risk and want to defer a portion of their RMDs, they may not be suitable for everyone. It’s important to consider your individual circumstances and possibly consult with a financial advisor before purchasing a QLAC.

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