As life expectancies increase, longevity risk–the risk of outliving retirement savings–is a concern for a growing number of people. In response, recent federal regulations created qualified longevity annuity contracts (QLACs), which are accessible through employer-sponsored plans, such as 401(k)s and IRAs.
What is a QLAC?
A QLAC is a type of longevity annuity that is held in an employer-sponsored plan such as a 401(k), 457(b), or 403(b) plan, and in IRAs. The premium paid to a QLAC is held for a number of years until distributions begin later in life, such as age 80. There are specific requirements and restrictions that apply to QLACs, including:
- The QLAC must generally be payable over the retiree's lifetime or over the lifetimes of the retiree and a beneficiary, and the interval between payments can be no longer than one year
- The QLAC must provide that payments begin no later than the first day of the month following the participant's 85th birthday, although an earlier starting age may be selected
- No more than 25% of any individual plan account balance may be allocated to a QLAC (including the value of the QLAC), and the value of all the retiree's IRAs are treated as a single plan for purposes of applying the percentage limit
- The total amount of all QLAC premiums paid by all retirement plans and IRAs over the participant's lifetime may not exceed $125,000, adjusted for cost-of-living increases, although inadvertent overfunding can be remedied if done in a timely manner
- QLACs may not include “cash out” or surrender provisions, and a QLAC may not be a variable annuity or an indexed annuity, nor can a QLAC be held in a defined benefit (pension) plan, Roth IRA, or Roth 401(k)
Caution: Annuity guarantees are subject to the claims-paying ability and financial strength of the annuity issuer. Annuities have contract limitations, exclusions, fees, expenses, termination provisions, and terms for keeping them in force. Investors may sacrifice the opportunity for higher returns that might be available in the financial markets, and inflation could reduce the future purchasing power of their annuity payouts.
Potential QLAC benefits
- QLAC balances during deferral are not included in calculating RMDs, reducing the amount of required distributions and the income tax bite associated with those distributions
- The amount and starting date of future QLAC distributions is predetermined, allowing a retiree to more accurately calculate how long income from retirement savings may need to last
- A QLAC may provide cost-of-living adjustments to potentially increase the income stream
- A QLAC death benefit may include a return of premium
Potential QLAC drawbacks
- QLACs are not liquid, have no cash surrender value, are generally irrevocable, and are not subject to growth potential during deferral years
- Retirement plan sponsors may not allow for the purchase of a QLAC within their retirement plan
- Funding a QLAC with a portion of a retirement account reduces the account balance available to provide income during the years before the QLAC distributions begin
- No payments will be made to a QLAC beneficiary if the annuitant dies before the payment start date, unless the contract owner has purchased an optional death benefit