What is a Qualifying Longevity Annuity Contract (QLAC)?

I’ve been getting a lot of questions about the Treasury Department’s recent release of final regulations that create a new type of annuity in the tax law: “Qualifying Longevity Annuity Contracts” (QLACs).

To explain, we first need to back up a step. This isn’t really a new type of annuity. This is simply a new tax treatment for types of annuities that already exist (specifically, certain types of deferred annuities) when they are purchased inside tax-deferred IRAs or tax-deferred employer-sponsored retirement plans.

Deferred Lifetime Annuities in General

A basic deferred lifetime annuity works like this:

• You pay a lump sum premium now (e.g., at age 65) to an insurance company, then
• Starting at a specific age in the future (e.g., age 85) the insurance company begins paying you a specific amount of money every month, and they continue to do so for the rest of your life.

In other words, these are much like the immediate lifetime annuities we often talk about here on the blog, except for the fact that the income doesn’t kick in for many years (hence, “deferred lifetime annuity”). And, because the payments don’t kick in for several years, the premium is much lower for a given level of income.

For example, as of this writing, for a 65-year-old female to purchase an immediate lifetime annuity paying $1,000 per month, the premium would be $180,384. In contrast, for a 65-year-old female to purchase a deferred lifetime annuity, for which payments begin at age 85, paying $1,000 per month, the premium would be $24,740. (These quotes are coming from the Income Solutions website.)

If deferred annuities of this nature have no appeal to you, then you do not need to worry about these new rules.

Effect of the New Regulations

Generally, with a traditional IRA or 401(k), you have to start taking required minimum distributions (RMDs) soon after reaching age 70.5. Thus, prior to the new rules, if you purchased a deferred lifetime annuity within your traditional IRA that pays nothing until, say, age 80, you could have a problem. The annuity is not liquid, so you might end up in a situation in which the liquid IRA balance is not sufficient to satisfy your RMD.

Now, this is no longer a concern. Under the new rule, as long as the annuity meets the requirements to be a “qualifying longevity annuity contract,” the value of the annuity would not be included in the value of your IRA — or 401(k) or other similar account — when calculating your RMD.

Requirements to be a QLAC

A deferred annuity must meet several requirements to be considered a QLAC.

First, payments must start no later than the first day of the month after the month in which you reach age 85.

Second, the annuity must not be variable annuity or “indexed annuity” (i.e., equity indexed annuity/fixed index annuity).

Third, the annuity cannot have much in the way of bells and whistles. Optional riders that would be allowed include:

• Inflation adjustments,
• Survivor benefits to a designated beneficiary, provided they meet a few specific requirements (e.g., in most cases the benefit to the survivor cannot be greater than the payments that were being made to the original owner), and
• A “return of premium” rider, wherein upon the death of the original owner, the designated beneficiary receives an amount equal to the premium(s) paid, minus any amount that has been paid out so far.

Finally, there are some dollar limits to be aware of:

• The total premium(s) paid for your QLAC(s) must not exceed $125,000,
• The total premium(s) paid for your QLAC(s) in IRAs (not including annuities in Roth IRAs) cannot exceed 25% of your total IRA balances (not including Roth IRAs), with IRA balances being measured as of 12/31 of the prior calendar year, and
• The total premium(s) paid for QLAC(s) in an employer-sponsored retirement plan cannot exceed 25% of your account balance in that plan.