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What is a Qualifying Longevity Annuity Contract (QLAC), and Who Should Buy One?

A reader writes in, asking:

“I have a question about changes to QLACs made in SECURE 2.0. The question is, do any of the changes make them more attractive in some cases? If so, what would be the general criteria for using a QLAC? Suppose you are in the fortunate position of not needing IRA funds in early retirement. Would the costs and risks of a QLAC, now updated by SECURE 2.0, be outweighed by the advantages of deferring taxes until age 85?”

First let’s go back over the basic information here: what’s a QLAC? Then we’ll discuss for whom a QLAC might make sense — and whether/how that has changed as a result of the SECURE Act 2.0 that was passed in late 2022.

A “qualifying longevity annuity contract” (QLAC) is a special tax treatment that can be given to a deferred annuity if it meets various requirements and if it is purchased inside a traditional IRA or tax-deferred employer-sponsored retirement plan, such as a 401(k).

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 immediate lifetime annuities, 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 $169,731. 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 $24,480. (These quotes are coming from ImmediateAnnuities.com.)

QLAC Tax Treatment

Generally, with a traditional IRA or 401(k), you have to start taking required minimum distributions (RMDs) upon reaching age 73 or 75, depending on your year of birth. Without special tax treatment, buying a deferred lifetime annuity that pays nothing until, say, age 80, could cause a problem if you were to buy that annuity within a traditional IRA. 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.

The special QLAC tax treatment eliminates this as a potential problem. As long as the annuity meets the requirements to be a qualifying longevity annuity contract, the value of the annuity is not 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 a 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, the total premium(s) paid for your QLAC(s) must not exceed $200,000.

What Was Changed by the SECURE Act 2.0?

Prior to the SECURE Act 2.0, the dollar limitation was lower, and the QLAC was not allowed to exceed 25% of your IRA or 401(k) balances.

In short, the changes made it so that people can buy bigger QLACs. But the changes didn’t make QLACs any more appealing. If a QLAC didn’t make sense for a given household before, it probably still doesn’t make sense now.

And in fact, if a QLAC is seen as a tool for delaying RMDs, then the SECURE Act 2.0 actually made QLACs slightly less useful, because it was that same piece of legislation that pushed the RMD age back to begin with. (That is, prior to the SECURE Act 2.0, the RMD age was 72. So QLACs effectively let you defer RMDs from 72 to 85, which is 13 years of deferral. Now, with the RMD age being 73 or 75, delaying to age 85 is fewer years of deferral.)

Who Should Buy a QLAC?

There are basically two sides to this decision:

  1. Does the household want a deferred lifetime annuity? (That is, ignoring the tax treatment, do they want an annuity of this nature in the first place?)
  2. Would the QLAC tax treatment be beneficial?

With regard to the first point, the value of such annuities is that they provide longevity protection at a lower cost than immediate lifetime annuities. So they’re most likely to be useful to a household that is concerned about longevity risk (i.e., in good health, and likely in that grey zone of “do we have enough?”).

But, at least in my view, the big problem with these contracts themselves is the inflation risk. To the best of my knowledge, no insurers offer QLACs with an inflation adjustment that begins at the time of purchase. (And from reading the applicable Treasury Regulation, I’m not entirely confident that such would even be allowed.) Rather, if a cost-of-living adjustment is provided, the adjustments begin when the payments begin. So the household is “on the hook” for any inflation that occurs between the time of purchase and the time the annuity payments begin.

Depending on when you buy the QLAC and when you have the payments start, that could be decades of inflation, which leaves a significant possibility that the income you ultimately receive is worth much less than you anticipated.

So when trying to determine who is the ideal candidate for a QLAC, we’re looking for a household that is concerned about longevity risk but not concerned about inflation. Frankly, I don’t really know who that would be.

As far as the tax treatment, for many households, the value of delaying RMDs from tax-deferred accounts until age 85 isn’t that valuable because they would be spending their full RMDs anyway. And that’s especially likely to be true for the households that are most exposed to the risk of portfolio depletion in long-life scenarios. In other words, the households most exposed to longevity risk (i.e., the households for whom a deferred lifetime annuity is most likely to be attractive) are the households for whom the deferral of RMDs (i.e., the unique tax planning feature of a QLAC) is least likely to be valuable.

In addition, for a married couple, if the tax planning goal of a QLAC is just to push income later into life, it’s worth noting that doing so also has the effect of pushing a greater portion of the income into the “single” filing status years instead of the “married filing jointly” years, which likely increases the applicable tax rate — though the size of survivor benefit selected for the annuity would be an important factor here.

So the ideal candidate for a QLAC is a household that is concerned about longevity risk (i.e., they’re in good health and concerned about portfolio depletion in a long-life scenario), yet they’re anticipating spending less than their RMD every year and are not concerned about inflation risk. It’s hard to think of a set of life and financial circumstances that would cause a household to be in such a position.

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