Recently, the Treasury Department issued final regulations governing qualified longevity annuity contracts (QLACs) that are likely to cause sparks to fly in the annuity industry in the coming years. While many of the final QLAC provisions mirror those found in the proposed regulations that were issued more than two years ago, the final regulations have made the Treasury’s commitment to expanding access to this valuable type of longevity insurance clearer than ever. Clients looking to minimize their required distributions from qualified plans while simultaneously securing retirement income late in life have been waiting since early 2012 for these rules, but the expansive final regulations are likely to appeal to a much wider client group who will need to pay attention to the details, both now and in the coming months.
QLACs: Then and Now
In general, a QLAC is a type of annuity contract that is purchased within a retirement plan — such as a 401(k)), 403(b) plan or traditional IRA. Payments under the annuity are deferred until the client reaches old age (though they must begin by the month following the month in which the client reaches age 85) in order to provide retirement income security late in life. The final regulations exclude Roth IRAs and further provide that if a QLAC is purchased within a traditional account that is converted or rolled over into a Roth, the contract will no longer qualify as a QLAC after the date of conversion or rollover.
The motivation for purchasing QLACs is heightened because the value of the QLAC is excluded from the retirement account’s value when calculating the client’s required minimum distributions (RMDs) once the client reaches age 70½. While the proposed regulations limited the annuity premium value of a QLAC to the lesser of $100,000 or 25 percent of the account value, the final regulations increased the set dollar value to $125,000, which will be adjusted annually for inflation. The final regulations also permit a client who accidentally exceeds the dollar or percentage limits to correct the excess payment without risking disqualification.
The final regulations clarify that the 25 percent limit is based upon the value of the account as of the last valuation date before the date upon which premiums for the annuity contract are paid. This value is increased to account for contributions made during the period that begins after the valuation date and ends before the date the premium is paid. The account value is decreased to account for distributions taken from the account during this same period.
Importantly, the final regulations provide for a “return of premium” feature that can provide peace of mind to clients who are interested in QLACs, but concerned that they will not live long enough to realize the benefits of the contract in old age. The return of premium feature allows the QLAC to provide that the premiums that have been paid, but not yet received as annuity payments, will be returned to the account if the client dies before they have been received.
Future possibilities for the QLAC
Both the proposed and final regulations exclude variable annuities, indexed annuities, and similar types of annuities that are closely tied to the performance of the equity markets from the definition of a QLAC. The rationale behind this rule is that the purpose behind the QLAC is to guarantee secure retirement income far into the future, and the income provided by variable and indexed annuities is arguably substantially more unpredictable than traditional fixed annuities.
Despite this, the Treasury has quietly left open the door for variable and indexed annuities to enter into the QLAC market. The final regulations provide that the IRS Commissioner has the authority to provide exceptions to the general prohibition against variable and indexed annuities through guidance published in the future.
This significant caveat leaves open the possibility that the market for QLACs, while almost certain to expand regardless, has the potential to grow substantially in the future if annuity carriers are able to convince the Treasury that variable and indexed annuities should be included as QLACs.
The mere fact that the Treasury’s QLAC regulations are now final is likely to create motivation among annuity carriers to make these products more widely available to clients, but the expansions that are included in the final regulations are what will create client demand for this annuity product that will not only reduce a client’s tax liability, but provide for income security late in life.
For previous coverage of the proposed regulations governing the use of longevity annuities in tax-preferred plans in Advisor’s Journal, see Planning for a Long Life: Longevity Insurance and Deferred Annuities.
For in-depth analysis of the minimum distribution requirements, see Advisor’s Main Library: Required Distributions.
Your questions and comments are always welcome. Please contact the Panel of Experts.