The Pros and Cons of QLAC Annuities

A qualified longevity annuity contract (QLAC) is an annuity that you fund through qualified retirement accounts. This type of annuity offers a guaranteed income stream and tax advantages, but it also locks up your money and may not earn enough to keep up with inflation.

QLACs came about in 2014 because of a very specific economic context: people are living longer, having longer retirements, and are less likely to have a pension. The U.S. Treasury enabled QLACs in 2014 by allowing consumers to purchase annuity contracts inside of a 401(k) or traditional IRA. These retirement accounts are often a person’s largest source of retirement savings.

The QLAC can be useful in that context because it offers retirees a steady income until they die. It guards against your nest egg running out before you die.

So is a QLAC a good choice for you?

Like every financial product, they have advantages and disadvantages. In this article, you’ll learn what the benefits of QLACs are, as well as their drawbacks, and whether they might be useful to you and your particular financial circumstances.

What is a QLAC?

A QLAC is a lot like other deferred income annuities. First, you buy the annuity and fund it through a lump sum premium payment. Your premium earns interest inside the annuity account and the value of the annuity grows over time.

What makes them different from other deferred annuities is how you buy them.

You buy a QLAC inside a pension, 401(k), individual retirement account (IRA), or another qualified retirement account. The assets you use to buy a QLAC are qualified which means that you have not yet paid income taxes on them. In fact, QLACs are the only way to buy an annuity that pays out at a later date with pre-tax money.

Another difference between QLACs and other annuities is that at the time of your purchase, you set a date in the future when you will begin receiving income payments. After the income payments begin, you will receive them for the rest of your life.

In other words, QLACs are more rigid than other types of annuities. You must annuitize them and you must receive annuity payments as a lifetime payout option. With other annuities, these are usually choices you can make.

Note: if you die before that date, you usually don’t receive any of your money. The life insurance company keeps it.

For example, imagine you buy a QLAC when you are 60 years old and you specify that it will start paying you regular income payments when you are 70 years old.

Now, if you die when you are 68, you won’t receive any money because the annuity won’t have started to pay you an income yet. The money will go to the insurance company (unless you have death benefits—see below).

On the other hand, if you live to 100, the insurance company will pay you an income every month from the time you turn 70 until you pass away; you would receive a steady income for 30 years.

QLAC Pros

Life expectancies are increasing and people are in retirement for longer, but pensions are becoming rarer and rarer. Enabling consumers to access their retirement account balance to buy a QLAC can and obtain a guaranteed stream of income in retirement is very useful for many people.

Here are some of the specific benefits QLACs offer.

Guaranteed Retirement Income

The biggest benefit of a QLAC — indeed, of any annuity product — is that it offers guaranteed retirement income. This provides certainty to retirees and can be a critical source of financial security. The regular payouts can supplement social security payments, pension payments, and other income sources as well as pay for food, rent, clothing, and even the occasional vacation.

Most of all, it helps you feel secure knowing that you’ll have money coming in regularly for the rest of your life.

Simple Structure

One complaint about annuity products is that they can be complex. Many people need some help understanding the basics of how annuities work.

QLACs have an extremely simple structure. That makes it easy to decide whether they could be a good option for you, and also how much of your retirement savings makes sense to store away in a QLAC.

Tax Deferral

Because the assets you use to fund a QLAC are qualified, the QLAC itself is qualified too (hence the “qualified” in the name). Qualified money is pre-tax money — you haven’t paid taxes on it. Instead, the income tax you owe on that money is deferred: rather than pay it when you earn it, you pay it later in life when you receive distributions from your annuity.

Tax deferral is beneficial to most people for two reasons.

First, most people receive distributions from their annuity in retirement when their income is relatively low. When your income is low, you will likely fall into a lower tax bracket and pay a lower marginal tax rate. That means that often, you’ll pay less tax on money that’s tax-deferred than you would if you paid tax on it when you earned it.

Second, because you don’t pay tax on your earnings right away, that money stays in your annuity account and earns interest. You end up earning more interest than you would have if you’d paid taxes immediately, so annuity account value grows faster.

For those two reasons, QLACs offer powerful tax advantages.

Note though, that you will have to pay ordinary income tax on your annuity withdrawals when you receive them. Learn more about the details of annuity taxation here.

Delayed Required Minimum Distributions (RMDs)

Tax-deferred retirement accounts typically face required minimum distributions. This is a rule from the IRS that requires you to make withdrawals from your retirement account after a certain age. As of September 2022, RMD rules state that once you turn 72, you must begin to start taking money out of your qualified retirement accounts.

However, QLACs are an exception to these standard RMD rules. When you buy a QLAC, that money is shielded from the RMD calculation, so your RMDs are lower. The money in your QLAC only faces RMDs after you turn 85.

Low Risk

QLACs are built to be safe places to put your retirement savings. Like fixed annuities, QLACs offer a fixed minimum interest crediting rate. That means from the time you buy your annuity to the time when your income payments start, you will earn that fixed minimum rate of return. The interest rate you are credited will never fall below that fixed minimum rate.

That makes QLACs very low-risk products — you know that your money will grow steadily. Then, once the annuity payments begin, you’ll receive a fixed amount for your entire life.

Beneficiaries

As you’re planning for retirement, you may consider how you’ll leave your legacy to your loved ones. Are QLACs a way to pass on any remaining retirement savings? What about your spouse — can a QLAC support them?

In the most basic version of a QLAC, no. If you die before the date you selected to receive your income, the insurance company keeps the money and it does not go to a surviving spouse or bneficiary.

But most insurance companies offer optional add-ons to help with legacy planning.

For example, QLACs typically allow you to add your spouse (or another beneficiary) as a second annuitant of your lifetime income payments, making it a joint annuity. If you choose this option, you and the beneficiary you select will receive income payments as long as either of you is alive.

You can usually choose to add death benefits to your QLAC. This would ensure that any beneficiaries you choose would receive any remaining premiums that are left after you die.

QLAC Cons

QLACs are essentially longevity insurance: they help to make sure that you won’t run out of funds when you get to the end of your life. While they can be a powerful addition to your retirement planning portfolio, they’re not for everyone.

Here are some of the drawbacks to owning a QLAC.

Illiquidity

When you buy a QLAC, you select the date when you start to receive your income. Once you buy it, you won’t see any money until that start date. You cannot withdraw money early or borrow against your premiums.

That can be a big risk. QLACs are very inflexible. That inflexibility may not suit all consumers.

If there is a chance you’ll need the money, it may not be a good idea to buy a QLAC. Many other annuity and insurance products, like fixed annuities from Canvas Annuity or other insurance companies, offer more flexibility. They usually let you withdraw your money at any time (although early withdrawals may face surrender charges or tax penalties).

You Could Lose Your Money

In its basic form, you lose the money in your QLAC if you die before it starts to pay you back. They can be a bit of a gamble.

Yes, you can include a beneficiary on a QLAC or add death benefits, and these can help protect against losing the annuity if you die earlier than expected.

No Market Exposure

QLACs earn a fixed minimum interest rate until the annuity begins to pay you back. That makes them very safe products because they are guaranteed to grow your money.

This means that they offer only limited rates of return. QLACs have no exposure to market risk and offer little of the potential upside that investing in securities like stocks or mutual funds can offer. The limited gains they offer can be a disadvantage.

There are other types of annuities that you can buy, such as variable annuities or fixed-indexed annuities. But these are riskier, and QLACs are not available in these types. You also cannot buy QLACs as an immediate annuity — you have to wait at least two years before annuitizing a QLAC.

Inflation

Inflation occurs when the cost of goods rises, and so the buying power of a currency falls. Typically, you want to earn a rate of return that’s higher than inflation so that your savings do not lose value.

One downside of QLACs is that they often do not offer an interest rate high enough to beat inflation. The result is that over time your money loses its buying power.

Investment Limits

You are limited in how much money you can put into your QLAC. As of September 2022, you can only contribute the lesser of $135,000 or 25% of your qualified account balance.

Most other annuity products don’t have this limitation.

Who is a QLAC Annuity Right For?

After all that, is a QLAC a good choice for you?

A QLAC could be a good choice for someone approaching retirement, who is in good health, and who has a significant chunk of retirement savings in a qualified retirement account. People considering a QLAC should also have enough money to sustain their current lifestyle and last them until the date their QLAC payments would begin.

A QLAC is probably not ideal for anyone who is facing health issues, or who may need their money before the date when the QLAC would start to pay them back. It’s also not ideal for individuals who have their retirement savings sitting outside of a qualified retirement account.

For anyone interested in the benefits of a QLAC, but who is nervous about locking their money away where they can’t reach it, consider a fixed annuity from Canvas Annuity. Their annuity products have many of the same advantages that QLACs have and some additional ones:

• They offer significant tax advantages through tax-deferral

• They offer strong, fixed minimum interest crediting rates
• They can provide a guaranteed lifetime income
• Their Flex Fund product lets you take your initial premium back anytime

These benefits make Canvas’ fixed annuity products a valuable alternative to QLACs. Apply today.