There’s a common anxiety that plagues millions of Americans today: the fear of outliving their retirement savings. This concern isn’t without merit given the rising cost of living, healthcare expenses, and increased life expectancy. However, a tax-advantaged annuity known as a Qualified Longevity Annuity Contract (QLAC) is a potential solution to this worry.
The Power of QLACs
Starting this year, Americans can use up to $200,000 of their retirement accounts to purchase QLACs, as set by Congress. This limit is a significant increase from the previous cap of $145,000 or 25% of your balance, whichever was lower. Annuities are essentially insurance contracts that provide a steady income, akin to a pension, making it easier to navigate the uncertain waters of life expectancy. In existence for over a decade, QLACs promise substantially more lifelong income than the usual immediate annuity, with the payments kicking off later in life – typically around the age of 80 or 85.
Mark Iwry, a former Treasury Department adviser instrumental in creating QLACs, argues, “More people should be able to take advantage.” QLACs can mitigate the burden and guesswork of self-managing retirement funds, a necessity given the shift from secure pensions to 401(k)s. Furthermore, they offer a tax advantage: reducing the balance of your retirement savings also lowers the size of the taxable withdrawals you’re required to make from age 73 onwards.
Balancing the Pros and Cons
However, QLACs come with a catch: they require an upfront cost and lack liquidity. The money you commit is locked in, and the size of the payout is contingent on how long you live. These factors shouldn’t be overlooked when considering a QLAC.
Charlie Walker’s example demonstrates the value of a QLAC. To reduce his annual tax burden and provide a supplementary income for his wife, Gloria, upon his passing, Charlie purchased a $108,000 QLAC from his IRA. This smart move will potentially help him avoid over $20,000 in taxable distributions over the next few years.
How QLACs Work
The QLAC works like this: at the outset of retirement, you transfer a portion of your savings to an insurer. This insurer then agrees to provide a set annual amount for life, starting a decade or two later. This way, you’re ensuring a guaranteed income stream later in life, regardless of how long you live.
Depending on the specifics of your contract, the payout may cease upon your death (or your spouse’s). However, many contracts offer a death benefit provision allowing your heirs to recover the purchase price, less any payouts made. The addition of a death benefit can lower the monthly payouts, but the deferred start date can increase the overall payout.
Tax Advantages of QLACs
QLACs also come with tax benefits. The funds transferred into a QLAC are no longer part of your retirement account balance, reducing the size of the required minimum distributions (RMDs) that begin at age 73. For instance, if your retirement account holds $1 million and you purchase a $200,000 QLAC, your RMDs will be calculated based on a balance of $800,000.
Where to Purchase a QLAC
QLACs can be purchased either through your company’s retirement plan or via the individual market through a financial planner, insurance agent, or brokerage. Major firms like Fidelity offer QLACs to IRA investors through a marketplace of insurers. While QLACs remain a niche insurance product, their potential market is vast, with $22.3 trillion currently in retirement accounts, according to the Investment Company Institute.
Why Consider a QLAC
Many underestimate their lifespan while planning for the future. A QLAC takes this uncertainty off your plate by transferring the market risk to the insurer. It provides a fixed-income safety net, allowing for a more aggressive investment strategy in other assets.
If you’re healthy and won’t require all your RMDs at the start of retirement, a QLAC can be an excellent choice, especially for women who tend to outlive men. QLACs offer a guaranteed income stream that doesn’t depend on market performance or investment skills. As Walter Pardo, a wealth adviser, explains, “Guys who say, ‘I could take the $200,000 and put it in Google,’ don’t see the value of the cash flow that this is going to provide for life.”
In conclusion, QLACs are not just a tax-advantaged annuity; they are a potential solution to a pressing problem. They provide a safeguard against outliving your savings, transforming the fear of longevity into an assurance of financial stability.
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