Sensible Perspectives

What is a Qualified Longevity Annuity Contract?

Posted by on August 18, 2015

Last month, I explained the differences between an immediate life annuity (guaranteed lifetime payments that begin immediately in exchange for a lump-sum premium) and a longevity annuity (guaranteed lifetime payments that begin at some future date in exchange for a lump-sum premium).  In this article, I will discuss a special type of longevity annuity called a Qualified Longevity Annuity Contract (“QLAC”).

A QLAC is a type of longevity annuity that you buy with pre-tax IRA monies.  Like all types of longevity annuities, a QLAC provides guaranteed income starting at some time in the future in exchange for a lump-sum payment today. What makes a QLAC special, however, is its preferential tax treatment.

Until recently, there was a serious problem with buying an annuity (whose payments may not begin until age 85) inside of an IRA (whose required minimum distribution [“RMD”] rules require that distributions begin at age 70.5). Let me illustrate with an example. Assume Larry, who is 70, has a $400,000 IRA as of December 31st and purchases a $100,000 longevity annuity that begins payments at his age 85. The following year, Larry must start taking RMDs due to his age. If the annuity is excluded from the value of Larry’s IRA, his RMD would be about $11,000. On the other hand, if the annuity were included in his IRA, Larry’s RMD would be almost $15,000. This situation seemed unfair, considering Larry has no access to the $100,000 for another 15 years and his taxes will be higher as a result of the larger IRA distributions.

Luckily, the Treasury implemented regulations last year that allow people to exclude a deferred annuity from their RMD calculation if it meets certain conditions, including

* Total annuity premiums are limited to 25% of one’s total pre-tax IRA balances (up to a maximum premium of $125,000)
* Payments must begin no later than age 85
* Payments must be fixed, i.e., not variable or equity-indexed
* The annuity must be irrevocable and illiquid (however it can have a return-of-premium death benefit payable to heirs)

An annuity that meets the above conditions (plus a few other rules) will be considered a Qualified Longevity Annuity Contract and will receive preferential tax treatment, i.e., its value will be excluded for purposes of calculating one’s RMD and its future payments will automatically satisfy its own RMD requirements.

So is a QLAC right for you? The decision whether to annuitize is complex and very specific to your circumstances. However, if you’ve determined that a deferred annuity has a role in your financial plan, a QLAC, even with its somewhat strict requirements, may be right for you.

Sensible Financial® has a number of ways to analyze how annuitization might fit into your financial plan. If you are interested in exploring this subject in greater detail, please contact your advisor.