QLACs: a smart strategy for retirement income and tax savings

In a move aimed at bolstering retirement security, the U.S. government introduced the Qualifying Longevity Annuity Contract (QLAC) more than a decade ago.

This financial tool provides longevity protection with tax advantages, enabling individuals to convert a portion of their Individual Retirement Account (IRA) or qualified retirement account into a guaranteed lifetime income stream.

What’s a QLAC

A Qualifying Longevity Annuity Contract is offered by insurance companies, most of which hold an A rating or higher. It can be purchased as a lump sum or in smaller increments, allowing flexibility in timing, amounts, and provider selection.

Each QLAC ensures guaranteed lifetime income beginning at a future date, up to age 85.

Payments can extend throughout the lifetimes of both spouses and continue to a beneficiary until the total premium amount has been distributed. Additionally, spouses can individually allocate a part of their IRA savings to a QLAC.

According to the Internal Revenue Service (IRS), the purpose of QLACs is to enhance the financial security of Americans in their later years by optimizing the use of retirement savings.

Changes to QLAC rules

The SECURE 2.0 Act, passed in December 2022, expanded the scope of QLACs by raising the maximum investment amount to $200,000.

Additionally, the legislation eliminated the previous rule that restricted QLAC payments to 25% of a person’s retirement account balance.

Starting in January 2025, the investment cap will increase further to $210,000. With this adjustment, an individual with $400,000 in their IRA can increase their QLAC allocation by more than 100%, from $100,000 to $210,000.

How QLACs work and their benefits

QLACs provide the advantage of guaranteed lifetime income, with the flexibility to delay payments until age 85.

Payments can also extend to a spouse and be transferred to a beneficiary until the full premium amount has been distributed. Each spouse can independently direct a portion of their IRA savings into a QLAC.

Funds from a rollover IRA, a 401(k), or a tax-advantaged annuity can also be directed toward a QLAC.

In such a scenario, investing $100,000 from an IRA at age 62 can secure a guaranteed annual income of $72,000 beginning at age 85. A 70-year-old woman investing $200,000 might receive $81,000 annually starting at age 85. These payout amounts have increased significantly since reaching a low point just three years ago.

For personalized estimates, individuals can use the QLAC calculator.

To encourage adoption, the government provides substantial tax benefits. Once an individual turns 73, contributions to this deferred income solution are excluded from the required minimum distributions (RMDs) formula, reducing taxable income and potentially lowering retirement taxes.

Income from a QLAC is taxed upon distribution, typically at age 85, but the tax impact can be minimized by applying it toward deductible expenses.

For instance, the 70-year-old woman in the earlier example could save approximately $2,000 annually in taxes if she were in a 25% tax bracket, accumulating to about $50,000 by age 85. Investing these savings could generate significant returns over time.

With millions of people turning 65 each year, the collective tax savings from QLACs could amount to billions annually.

Applying QLACs in retirement planning

This specialized annuity offers flexibility in retirement planning, allowing for personalized income streams based on individual needs.

A one-time purchase with deferred payments until age 85 provides longevity protection and tax advantages. Alternatively, making multiple purchases at different times can create an income ladder, ensuring payments increase at various stages of retirement.

For example, a woman in the mentioned scenario could set up her QLAC to start providing income at age 75, with payments gradually rising to $37,000 by the time she reaches 85. By structuring deferred payments in this way, the strategy helps counteract inflation while maintaining a stable and increasing income throughout retirement.

The annuity payments adjust based on prevailing interest rates, meaning that if interest rates rise, the annuity holder could potentially receive higher returns.

By comparing different annuity providers and their respective rates, individuals can significantly enhance the financial benefits of their QLAC, maximizing its role as a retirement income tool.

One of the most significant advantages of longevity annuities is their ability to defer taxes, enabling retirees to optimize their income and reduce tax liabilities over time.

Additionally, retirees may benefit from tax deductions on certain expenses, further optimizing their retirement strategy.

By strategically incorporating this annuity into their retirement income plan, individuals can secure a higher income stream while effectively lowering their overall tax obligations, including retirement taxes.

QLACs stand out as an essential component of retirement income planning due to their enhanced flexibility and significant tax benefits, both of which contribute to greater financial security in later years.

Retirees can achieve a more stable and secure financial future by taking advantage of the increased flexibility, tax benefits, and potential deductions that longevity annuities provide within their overall retirement income strategy.