As financial planners, we are always looking for creative ways to help our clients keep their money invested as long as possible while reducing tax burdens. Preparing inflation-ready retirement withdrawals has recently been a top concern. Required minimum distributions (RMDs) create additional tax-planning concerns which can be remedied through qualified longevity annuity contracts (QLACS).
A qualified longevity annuity contract (QLAC) is a financial planning tool that allows individuals to delay retirement payments while increasing income and longevity insurance benefits.
Let’s dive into QLACs and the benefits they provide to financial advisors and their clients. We’ll also discuss the downsides of using QLACs to defer RMD obligations and strategies financial advisors can consider when recommending one. First, here are some key takeaways:
- QLACs’ deferred start date can help investors defer RMDs.
- QLACs have a decreasing payout rate that reduces RMD income over time.
- QLACs may be suitable for clients with limited investment assets or lower incomes.
What is a QLAC?
QLACs are fixed, deferred annuities funded by a qualified retirement plan or an individual retirement plan (IRA). They offer longevity features, such as the ability to postpone required minimum distributions until a certain age (the maximum is 85). RMDs are calculated using the life expectancy tables.
QLACs provide annuity holders with extra flexibility by deferring income payments yet enabling them to receive payout income at any time within the contract term. For example, your client may postpone income payments for 10 years, and thenreceive a monthly payout.
How QLACs work
The age of RMDs has been a moving target. The initial Secure Act facilitated some change: Clients who reached age 70 ½ in 2020 or later must take their first RMD by April 1 of the year after they reach 72. On Jan. 1, 2023, Secure 2.0 raised this age to 73 for retirees born in 1959 or after. Down the road, Secure 2.0 raises RMDs to age 75 for people born in or after 1960.
QLACs provide an alternative solution to lower RMDs and keep that money invested longer. The rules are unique because investors can defer withdrawals until age 85.
As long as your client’s QLAC assets are held in an IRA or an employer-sponsored 401(k) or similar plan, your client can postpone and defer RMDs throughout their lifetime. They can delay when RMDs are taken out of the account by rolling them into more QLACs each time one matures.
QLAC contribution limits
In 2023, QLAC contribution limits are 25% of the IRA or 401(k) (or a similar) account balance or $155,000, whichever is lower. The contribution limit is up from $145,000 in 2022 and $135,000 in 2021.
However, the Retirement Plan Simplification and Enhancement Act may make it easier for clients to stash away money. Itproposes new rules to repeal the 25% limit and increase QLAC contributions to $200,000.
Who QLACs are best suited for
QLACs are a way to address longevity, income stability, and inflation for some clients. They may be best suited for risk-intolerant clients because they can provide income regardless of market performance and longevity risk.
Insurance companies can set different restrictions on how and when a QLAC can be opened. The minimum age is typically 18 years, while some companies may limit annuities with longevity features to ages 21 and up.
Many companies have minimum purchase amounts to open a QLAC. For example, for income-qualified investors who do not wish to annuitize their funds, a minimum income of $25,000 (for joint accounts) or $10,000 (for individual accounts) per year may be required to invest in such products.
QLACs have a maximum contribution amount based on total qualified assets, which must be carefully considered before moving forward with investing.
Additionally, withdrawing money from a QLAC can be subject to retirement taxes and penalties. As a result, QLACs may not be suitable for investors who want access to a wide range of investments or who plan on making frequent withdrawals. Therefore, advisors should consider their client’s goals and needs when recommending QLACs as an RMD deferral strategy.
How QLACs can reduce your clients’ taxes
Clients buy QLACs with pre-tax retirement savings, meaning they can move funds from their 401(k) or IRA without being taxed or penalized. The account value doesn’t increase over time, so clients avoid taxes on interest or capital gains. Additionally, because the withdrawals can be deferred until age 85, clients can defer a portion of their RMD and may pay less income tax on withdrawals.
Standard payout options
Your client’s payout options depend on the terms of the contract and can vary from one policy to the next. However, standard payout options include:
- Single life only: The contract pays a guaranteed, lifelong income based on life expectancy. However, there is no death benefit.
- Joint life only: The annuity owner and spouse receive a guaranteed, lifelong joint income based on life expectancy. There is no death benefit after both insureds die.
- Lifetime income with cash refund: The annuity pays a guaranteed, lifelong income. Beneficiaries will receive a cash refund (lump sum) of the remaining initial premium if the contract owner dies before the annuity completes the payout.
Pros and cons of QLACs
Financial planners considering QLACs should note that the product is only suitable for some customers. The pros and cons suggest that the product is better suited for clients who want to ensure a stable source of income and want to mitigate the risk of outliving their savings.
- Retirement-income flexibility.
- Deferring RMDs until age 85.
- Can help reduce taxable income.
- Distribute tax-advantaged wealth for beneficiaries.
- Limit on contribution amounts.
- Product fees and statutes.
- Some contracts may pay lower interest rates than your client desires.
A QLAC mainly benefits investors by deferring taxes associated with RMDs. However, financial planners can also consider QLACs for clients who want savings to last longer than traditional retirement account savings.
Marguerita (Rita) Cheng, CFP, is the chief executive officer of Blue Ocean Global Wealth.She is passionate about helping clients navigate some of life’s most difficult issues — divorce, death, career changes, caring for aging relatives — so they can feel confident and in control of their finances. Rita is a regular columnist for Kiplinger and MarketWatch, and a past spokesperson for the AARP Financial Freedom Campaign. Rita volunteers her time as a SoleMate, or charity runner for Girls on the Run, raising money to win scholarships for girls.