Longevity Insurance and QLACs

One of the biggest financial risks in retirement is outliving your savings. A Qualified Longevity Annuity Contract (QLAC) addresses this concern by providing guaranteed income that begins late in retirement, typically at age 80 or 85, when other resources may be depleted.

What Is a QLAC?

A QLAC is a type of deferred income annuity that you purchase with funds from your qualified retirement accounts, such as a Traditional IRA or 401(k). You pay a premium today, and in exchange, the insurance company guarantees monthly payments starting at a future date you select.

The key features that distinguish QLACs from regular annuities:

• Purchased with qualified retirement funds: You use pre-tax money from IRAs or employer plans
• Deferred income start: Payments begin at an age you choose, typically between 70 and 85
• RMD exclusion: The amount in your QLAC is excluded from required minimum distribution calculations until payments begin
• Contribution limits: You can invest up to $200,000 or 25% of your retirement account balances, whichever is less

Current Contribution Limits

The IRS sets maximum amounts you can allocate to QLACs:

For example, if your total IRA balance is $600,000, your 25% limit would be $150,000. Since this is less than the $200,000 dollar limit, you could invest up to $150,000 in a QLAC.

If your total IRA balance is $1,000,000, your 25% limit would be $250,000. However, the $200,000 dollar cap applies, so your maximum QLAC investment is $200,000.

How RMD Reduction Works

Required minimum distributions normally begin at age 73 (as of 2023 rules). The IRS calculates your RMD based on your account balance divided by a life expectancy factor. When you own a QLAC, the premium amount is excluded from this calculation.

This exclusion continues until your QLAC payments begin. At that point, the payments themselves become taxable income, but you've effectively delayed and restructured when that money is taxed.

Income Start Ages and Payout Rates

QLAC payout rates increase significantly the longer you defer the start date. Insurance companies can offer higher payments because:

1. Fewer purchasers survive to very advanced ages
2. The premium has more time to grow
3. The expected payout period is shorter

Typical monthly payout per $100,000 premium (approximate, varies by insurer and rates):

These figures are estimates. Actual quotes depend on current interest rates, your age at purchase, and the specific insurance company.

Worked Example: $150,000 QLAC Purchased at Age 70

Robert is 70 years old with $800,000 in his Traditional IRA. He's concerned about running out of money if he lives into his 90s. He decides to purchase a $150,000 QLAC with income starting at age 85.

Purchase Details:

• Purchase age: 70
• Premium: $150,000
• Income start age: 85
• Deferral period: 15 years

Immediate Impact on RMDs:

Before the QLAC purchase, Robert's RMD at age 73 would be calculated on $800,000. After the purchase, his RMD is calculated on $650,000.

Robert reduces his taxable income by approximately $5,661 in year one. If he's in the 22% tax bracket, this saves him about $1,245 in federal taxes that year.

Income at Age 85:

Based on current payout estimates, Robert's $150,000 QLAC might provide approximately $1,500 per month ($18,000 per year) starting at age 85.

If Robert lives to age 95, he will have received $180,000 from his $150,000 investment. If he lives to 100, he will have received $270,000. The longer he lives, the more valuable the QLAC becomes.

Optional Features and Their Costs

QLACs can include optional features that affect payouts:

Return of Premium (ROP) Rider: Guarantees that if you die before receiving your full premium back, your beneficiaries receive the difference. This feature reduces your monthly payment by 10-20%.

Cash Refund Option: Similar to ROP, ensures total payments at least equal your premium. Also reduces monthly income.

Who Should Consider a QLAC?

A QLAC may be appropriate if you:

• Have significant assets in Traditional IRAs or 401(k)s
• Are concerned about longevity risk
• Want guaranteed income in late retirement
• Wish to reduce RMDs and current taxable income
• Have other resources to cover expenses before the QLAC payments begin

A QLAC may not be suitable if you:

• Need access to all your retirement funds for near-term expenses
• Have health conditions that significantly reduce life expectancy
• Have limited retirement savings overall
• Want flexibility to adjust your withdrawal strategy

Tax Considerations

All QLAC payments are taxed as ordinary income in the year received, just like other Traditional IRA distributions. The RMD reduction shifts taxation from your 70s to your 80s and beyond, which may be advantageous if:

• You expect to be in a lower tax bracket in later years
• You want to manage your taxable income to stay below IRMAA thresholds for Medicare
• You prefer to leave more in your IRA to grow tax-deferred

Checklist: Evaluating a QLAC

• Calculate 25% of your total qualified retirement account balances
• Compare your 25% limit to the $200,000 maximum to find your applicable limit
• Obtain quotes from at least three insurance companies
• Compare payout rates for different income start ages (75, 80, 85)
• Decide whether you need a return of premium or period certain feature
• Calculate how the QLAC will reduce your RMDs
• Verify you have sufficient other assets to cover expenses until QLAC payments begin
• Review the insurance company's financial strength ratings (AM Best, S&P, Moody's)
• Understand that QLACs are irrevocable once purchased
• Consult with a tax professional about the income timing implications