A big problem confronting those with significant retirement savings is that the money that they have accumulated is “qualified” money (sometimes abbreviated “TQ”). That is, money that has “grown” without being reported on the annual tax report to the IRS. Upon reaching 70½ years old, the IRS requires at least minimum distributions from those retirement accounts.
In other words, the IRS is saying, “OK, we’ve allowed you to earn money for retirement without paying taxes on the gains all these years. Now, it’s time take some of that money for your retirement years, pony-up, and pay us (their middle name is, after all, ‘revenue’) on that formerly income-tax free account.”
In July 2014, however, the Treasury Department released the final regulations allowing for the creation of a Qualified (money) Longevity Annuity Contract or QLAC. These new annuities will offer a unique tool to help people avoid outliving their money. It will also help people avoid having to take the required minimum distribution (RMD) from the qualified account, allowing all or part of the money to retain value and continue growth.
The QLAC rules, however, are a complicated mash-up of IRA and annuity rules, and people may need substantial help in understanding their key provisions. It is highly recommended that, if you are a consumer, you talk to your tax advisor, and if you’re an advisor, encourage your clients to talk to their tax advisor if you don’t offer these services. Consumers are strongly encouraged to contact an annuity sales or consultant professional prior to attempting to set up a QLAC.
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Below are five critical QLAC questions and their answers, as they exist at this date.
So, what are QLACs?
QLAC stands for qualifying longevity annuity contract, a new type of fixed longevity annuity. A longevity annuity is a relatively new concept in that the person buys an annuity (single-premium immediate annuity or SPIA), but postpones taking the income stream until some specified time in the future to avoid the risk of running out of money. Since the contract holder has given up the money in exchange for an income stream, there is technically no account value from which to take RMDs, so, none are due at 70½.
The contract itself is held in a retirement account and has special tax treatment. Distributions from QLACs don’t have to begin until a client reaches age 75, 80 or 85 (depends on how the contract is designed), well beyond the ages at which RMDs normally begin. The older one gets, the higher the payout rate of the annuity — it’s like a phantom account in which the value has “grown” over time.
When payments do begin, however, the entire distribution is income-taxable at the then-current tax rate. Tax laws can change and differ state to state. A qualified tax advisor should be consulted before purchasing a QLAC.
Why did the Treasury Department create QLACs?
Since 70½-year-olds might not need or want to take RMDs, they had few choices in avoiding RMDs for qualified (tax-deferred) retirement money. And, the choices they did have were challenging due to the tax-favored treatment of qualified money.
Without going into the technical details, without the QLAC, qualified account holders needed to:
1) Begin taking distributions (RMDs) from their qualified retirement accounts, reducing their account value and, by extension, their potential future monetary benefit, or…
2) Start taking an income stream now (“annuitize” the account), which would obviously produce a lower income stream than it might if they were to postpone taking an income stream until later at a more advanced age, or…
3) “Make-up” the RMDs from other qualified account assets, drawing down those assets at an accelerated rate. None of these options was particularly attractive and now, thanks to QLACs, clients will no longer be forced to make such decisions.