A qualified longevity annuity contract (QLAC) is a deferred annuity funded with an investment from a qualified retirement plan or an individual retirement account (IRA). They are available for purchase through many insurance companies.

A QLAC provides guaranteed monthly payments that begin after the specified annuity starting date. As long as the QLAC complies with Internal Revenue Service (IRS) requirements, it is exempt from required minimum distribution (RMD) rules until the owner reaches age 85.

Understanding a Qualified Longevity Annuity Contract (QLAC)

A QLAC is an investment vehicle that allows funds in a qualified retirement plan, such as a 401(k), a 403(b), or an IRA, to be converted into an annuity.

An annuity is a contract purchased from an insurance company in which the buyer pays a lump sum or a series of premiums. The insurance company pays the annuitant beginning on a predetermined start date. How many years the owner receives payments depends on the type of annuity purchased.

The SECURE 2.0 Act of 2022 allows individuals to move $200,000 to a qualified longevity annuity contract. It adjusts the $200,000 limit annually for inflation, and the legislation recently removed the rule capping QLAC premiums at 25% of the participant's total plan assets.

A QLAC provides a lifetime income once the preset annuity start date is reached. The longer an individual lives, the longer a QLAC pays out. Using IRA funds to purchase a QLAC helps avoid violating the IRS RMD rules mandating a minimum amount to be annually withdrawn from an individual's retirement account balances beginning at age 73 and increasing to age 75 in 2033.

A QLAC allows distributions to be delayed until a predetermined payout date but no later than the person's 85th birthday. A QLAC also allows a spouse or other party to be a joint annuitant where both named individuals are covered with the same conditions regardless of how long they live.

Qualified Longevity Annuity Contracts and Taxes

QLACs have the added benefit of reducing an individual's RMDs, which IRAs and qualified retirement plans require. Limiting RMDs can help keep a retiree in a lower tax bracket, with a tax benefit and reduced Medicare premium.

Once QLAC income begins, an individual's tax liability will increase. The annual distribution is based on the account's value at the end of the preceding year. The promised benefit of QLACs can only be achieved if rules set by the IRS are followed.

Qualified Longevity Annuity Contract Options

One option to benefit from QLACs is by laddering them and purchasing one QLAC each year for several years. Such a strategy is similar to dollar-cost averaging, which considers that annuity costs can fluctuate along with interest rates. In other words, a QLAC could be purchased each year, lowering the average cost of the contracts.

All laddered annuity contracts can be structured to begin paying out in the same year. Each contract could also have its payouts staggered to pay out in different years based on the owner's age and when the income is needed. The first QLAC purchased could begin paying out at age 78, the next at age 79, and continue. However, RMDs are required at age 85. QLAC buyers can add a cost-of-living adjustment to their contract, which indexes the annuity against inflation. Deciding on this depends on life expectancy, as the cost-of-living adjustment will reduce the QLAC’s initial payout.

Example of a QLAC

Shahana is 67 and due to retire in three years. She would like to save on tax liabilities from her RMDs. Based on her current retirement account balances, Shahana's first-year RMD is estimated at $84,000 when she turns 73. She has investments in other assets, such as stocks, bonds, and real estate, which should provide her with an income stream during retirement. She also plans to consult part-time to stay current in her field. Shahana invests $100,000 in a single premium QLAC account from her IRA savings to withdraw when she turns 85. This will delay her RMD withdrawal date for the $100,000 used to purchase the QLAC. When Shahana turns 85, she'll have guaranteed income from the QLAC for the rest of her life. The money set aside in the QLAC is excluded from her IRA assets when determining her annual RMDs until she turns 85, resulting in lower current income taxes. However, she will eventually pay income taxes on the distribution amounts from the QLAC and likely a lower tax bracket at age 85.

The Bottom Line

A QLAC is a deferred annuity funded from a qualified retirement account, such as an IRA. You can purchase a QLAC from an insurance provider and set a designated date for your payments to begin. IRS rules stipulate that required minimum distributions begin at age 85 from the QLAC. Transferring money to a QLAC reduces a retiree's annual RMD calculated on other retirement accounts.