If You Hate RMDs, You Might Love QLACs
A newer feature on certain deferred income annuities can help you with RMDs ... and you've probably never heard of it.
In July of 2014 the Treasury Department approved the use of Qualifying Longevity Annuity Contracts* (QLAC for short) in what was arguably one of the biggest changes impacting retirement savers since the Roth IRA in 1997. The problem is, virtually no one heard of this announcement: clients, accountants, even most financial advisers.
Almost five years later this is largely still the case. LIMRA reports that total annuity sales in the U.S. in 2018 were over $232 billion, whereas deferred income annuities (of which QLAC is only a subset) were just $2.3 billion. Part of the reason why people likely haven’t heard of QLACs is because unless their financial advisers also have their insurance licenses, they can’t offer one to their clients and not every insurance company even offers them.
So, what is a QLAC? It’s a deferred income annuity purchased inside of an IRA or 401(k) (though most large providers only allow it to be funded from an IRA). The most you are allowed to contribute, per IRS guidelines, is the lesser of 25% your aggregate IRA balances as of December 31 of the prior year or $130,000 (2019 figure). So, if you had $520,000 in your IRAs you could contribute $130,000, but no more.
As a reminder, an income annuity is simply an annuity contract under which you give an insurance company a sum of money in exchange for a pension-like payment for as long as you live (and potentially your spouse as well). Many retirees find this predictable income stream beneficial to cover fixed expenses (especially with fewer and fewer traditional pensions provided by employers), taking some pressure off the market return expectations on the rest of their portfolio.
Here’s where it gets interesting: There are no required minimum distributions (RMDs) due on the QLAC money while waiting for the income to start (as late as age 85). So in the previous example, if you had $520,000 in your IRA, but rolled $130,000 into a QLAC IRA, your RMDs would only be calculated on $390,000. To put that in perspective, at age 70½ that’s a $4,744.52 difference in RMDs, and at 75 it would be a difference of $5,676.85. When the QLAC income begins it will, of course, be treated as ordinary income as payments are made as all traditional IRA distributions are.
Something to keep in mind about QLACs (and income annuities in general): Many companies allow you to have “joint annuitants,” meaning the monthly payments will continue as long as you, or your spouse, are alive. If you both pass away before payments have begun, or before you’ve gotten as much as you put in, many contracts today have a “life with cash refund option.” This slightly reduces the payment amount, but it allows that unused balance to go to children or other beneficiaries of your choosing.
To give you an idea of what one pays, let’s say you have a 65-year-old couple. The husband puts $130,000 into a QLAC and selects joint annuitants with cash refund. If they wait until age 80 to begin receiving payments, it would pay out $19,713 per year (as long as either spouse is alive). If they wait until age 85 (the max allowed), that payment jumps to $33,408 per year.
Who can purchase a QLAC? Almost anyone, but in practice I generally see them in play for clients 55+ who are starting to think seriously about their retirement income and who are concerned about outliving their assets. However, even someone over 70½ who has already begun RMDs can purchase one, although usually they aren’t allowed past age 80.
Why did the government come out with QLACs? Part of the reason is to allow people to minimize their RMD obligations, which many clients find attractive. The other big reason, however, is in the name: Longevity. People are living longer than ever and with so few pensions these days, an income annuity is one of the only ways to guarantee income in retirement, especially those critical later years when other expenses like extended care needs can start to pile up.
In addition, there are several other factors to consider when looking at a QLAC: overall assets, liquidity and health, just to name a few; however, if properly understood and deemed to fit in, the QLAC has the potential to be a powerful tool in your retirement planning toolkit.
This article was written by Caleb Harty for informational purposes only, and the content does not necessarily represent the views of Eagle Strategies LLC or its affiliates. This is not a solicitation of any particular product. *QLACs are subject to important restrictions and limitations and neither Harty Financial or its staff, nor Eagle Strategies LLC or its advisers/affiliates provide tax, legal or accounting advice. Please consult your own tax, legal or accounting professional before making any decisions.
Caleb Harty is an Investment Adviser Representative of Eagle Strategies LLC, a Registered Investment Adviser and a Registered Representative offering securities through NYLIFE Securities LLC, (member FINRA/SIPC), a Licensed Insurance Agency, 189 N. Main St., Middletown, MA 01949. Eagle Strategies LLC and NYLIFE Securities LLC are New York Life Companies. Harty Financial is not owned or operated by NYLIFE Securities LLC or its affiliates. For more information visit hartyfinancial.com.
About the Author
Founder and Principal, Harty Financial
Caleb is a principal at Harty Financial and a CERTIFIED FINANCIAL PLANNER™ (CFP®). He has his BA in Economics from Gordon College in Wenham, Mass. Caleb is one of only a few advisers in the New England area who specialize in working with families that have a child with special needs. The connection is a personal one, as his brother-in-law has Down syndrome. He also focuses on holistic financial planning for successful professionals, business owners and those approaching retirement.
Caleb Harty is an Investment Adviser Representative of Eagle Strategies LLC, a Registered Investment Adviser and a Registered Representative offering securities through NYLIFE Securities LLC (member FINRA/SIPC), a Licensed Insurance Agency, 189 North Main Street, Unit 2A, Middleton, MA 01949. Phone: 978-972-5961 Eagle Strategies LLC and NYLIFE Securities LLC are New York Life Companies. Harty Financial is not owned or operated by NYLIFE Securities LLC or its affiliates.