QLACs: Deferring RMDs and Extending Retirement Income Horizons

Qualified Longevity Annuity Contracts (QLACs) offer a powerful strategy for retirees seeking to manage Required Minimum Distributions (RMDs) and extend the runway of their retirement income. At their core, QLACs are deferred annuity contracts purchased within a qualified retirement plan, such as a 401(k) or IRA. What distinguishes them is their specific design to delay income payments until later in life, effectively pushing back the point at which those funds become subject to RMD rules.

The mechanism for RMD deferral hinges on a specific provision within IRS regulations. Generally, RMDs are calculated annually based on the prior year-end balance of all qualified retirement accounts. However, funds allocated to a qualifying QLAC are carved out from this calculation, at least temporarily. This means that the portion of your retirement savings used to purchase a QLAC is essentially removed from the RMD equation until annuity payments commence.

This exclusion works because the IRS recognizes that QLACs are designed to provide income at a future date, often well beyond the age at which RMDs typically begin. By allowing the exclusion, the government acknowledges the purpose of QLACs in addressing longevity risk – the risk of outliving one’s retirement savings. Essentially, the funds within the QLAC are earmarked for future income and are not considered immediately available for distribution in the present RMD calculation.

Let’s illustrate this with an example. Imagine a retiree, Sarah, with $1,000,000 in her IRA as she approaches age 73, the current age for RMDs to begin. Without a QLAC, her RMD would be calculated based on this full $1,000,000. However, if Sarah decides to invest $200,000 (or the applicable limit) into a QLAC, that $200,000 is no longer included in her RMD calculation. Her RMD will now be based on the remaining $800,000 in her IRA. This immediately lowers her annual RMD obligation.

The deferral benefit continues until Sarah reaches the age when her QLAC payments are scheduled to begin. Crucially, the funds within the QLAC continue to grow tax-deferred during this period. This tax-deferred growth is another significant advantage, allowing for potentially greater accumulation of wealth within the QLAC before income payments start.

Furthermore, once QLAC payments begin, they are then subject to taxation as ordinary income, just like any other retirement plan distribution. However, the key advantage remains – the deferral of RMDs in the years leading up to the annuity payments. This deferral can be particularly beneficial for individuals who:

• Do not need the immediate income: If a retiree has sufficient income from other sources and doesn’t require immediate access to their full retirement account balance, deferring a portion of RMDs can be advantageous.
• Anticipate higher tax brackets in the future: While deferring taxes isn’t always beneficial if future tax rates are significantly higher, for many, pushing income and taxation into later years can be a strategic move, especially if they anticipate being in a similar or lower tax bracket in the future or are managing their tax liability across different years.
• Are concerned about longevity risk: QLACs are explicitly designed to address the risk of outliving savings. By securing a stream of income that begins later in life, retirees can create a safety net for their very late retirement years.
• Want to maximize tax-deferred growth: The funds within a QLAC continue to grow tax-deferred until payments begin. This compounding growth over time can significantly enhance the overall value of the annuity.

It’s important to acknowledge the limitations and considerations associated with QLACs. There are limits on the amount that can be invested in a QLAC, currently capped at $200,000 (indexed for inflation) or 25% of the aggregate balance of the qualified retirement accounts used to purchase the QLAC, whichever is less. Additionally, once a QLAC is purchased, it is generally irrevocable, meaning you typically cannot access those funds before the annuity payments begin. This lack of liquidity is a crucial factor to consider. Finally, QLAC payments cannot begin after age 85.

In conclusion, QLACs offer a sophisticated strategy for deferring RMD obligations within qualified retirement plans. By strategically allocating a portion of retirement savings to a QLAC, individuals can reduce their immediate RMD burden, benefit from continued tax-deferred growth, and secure a future income stream to mitigate longevity risk. While not suitable for everyone, for those with a long-term retirement horizon and a desire to optimize RMDs and secure later-life income, QLACs can be a valuable tool in advanced retirement income planning.