The income from required minimum distributions (RMDs) is your reward for having diligently funded your retirement accounts. But the no-free-lunch principle applies: RMDs are taxable. In addition, because they reduce the value of your retirement accounts, you’ll have less to draw on in future years, especially if you have a long lifespan.
You must start taking RMDs from your IRA, 401(k) plan or other qualified retirement plan when you reach age 73. The only good way to defer some of them is to transfer a portion of your retirement plan assets to a qualified longevity annuity contract (QLAC). The money in a QLAC is excluded from plan assets on which RMDs are calculated.
A type of deferred lifetime income annuity that meets IRS requirements, a QLAC lets you keep more of your retirement plan intact and tax-deferred longer. Under the SECURE 2.0 Act, an individual can place up to $200,000 in a QLAC. You must start taking income payments from a QLAC at 85 but may begin sooner.
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To purchase a QLAC, you’ll transfer funds from your IRA, 401(k) or other eligible retirement plan to an annuity with a life insurer. This single premium funds the QLAC. Because the transfer is from one plan custodian to another, it’s tax-free.
Lifetime guaranteed income reduces financial risk
Many people run the risk of running out of money if they live to a ripe old age. A QLAC reduces that risk because its payments, just like pension-plan income, are guaranteed to continue at the same level no matter how long you live, even if it’s past 100.
QLACs have an accumulation phase where interest earnings are held and reinvested by the insurance company, and a payout phase, also called annuitization. Future income is guaranteed. You’ll know what the guaranteed payout will be before depositing your funds.
You choose when to start receiving a stream of monthly lifetime income, but it must be by age 85 at the latest. Like other retirement plan distributions, the income will be fully taxable then. But you’ll have gained a number of years of valuable deferral of income taxes.
You don’t have to invest $200,000 all at once. You could start with, say, $75,000 in one QLAC and place $125,000 in a second QLAC later on. You could stagger the income start dates, with the first QLAC paying out when you reach 80 and the second one staring at 85, for example.
The QLAC limit of $200,000 is the current lifetime limit. The amount will be adjusted for inflation in future years.
Delaying RMDs isn’t the only benefit. More important, you’ll create a larger stream of income you can’t outlive. You can buy a QLAC at any age. The earlier you buy a QLAC, the longer you get to build up principal and the bigger payout you’ll ultimately receive.
Because you’ll have a new source of future guaranteed income, you may be comfortable taking more market risk with other assets in your plans and potentially getting higher returns.
A look at your payout options
As with any deferred income annuity, you’re no longer in control of the principal with a QLAC. You’ve deposited it with an insurer in exchange for a contract for future income.
You can choose an individual or a joint lifetime payout, with the latter paying out income until the second spouse dies. The joint payee must be a spouse under IRS death-transfer rules. Most married individuals choose the joint option so that their spouse will still get lifetime payments if they predecease him or her.
With the cash-refund option, beneficiaries will get a lump-sum payout for any of the initial deposit premium not yet paid out at the death of the annuitant(s). Most insurers reduce future monthly payments if you choose this option.
Shop around for the best deal on QLACs
QLACs are offered by many life insurers. The market is competitive, and payouts and contract provisions vary considerably.
If you consider products from only one or two insurers, it’s unlikely you’ll get the best deal. An annuity agency that offers products from many insurance companies should give you expert advice and help you make apple-to-apple comparisons.
The agency earns a commission, but it’s paid by the insurance company, not the buyer. All of your deposit goes to work for you immediately.
Review the insurer’s financial strength, as judged by AM Best and other credit rating agencies, because you’ll need a company that can deliver on its promise for many years.
QLACs aren’t for everyone. If you need all of your RMDs for living expenses, you won’t be able to afford to defer some. But many retirees can benefit from this product that’s designed to give you a bigger future stream of income for your life or the life of your spouse.
Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed, and lifetime income annuities. Ken is a nationally recognized annuity expert and widely published author. A free rate comparison service with interest rates from dozens of insurers is available at www.annuityadvantage.com or by calling (800) 239-0356.
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