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Robert Bloink and William H. Byrnes

Retirement Planning > Spending in Retirement

How QLACs Can Help Clients Manage Inflation Risk, Reduce RMDs

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What You Need to Know

  • Qualified longevity annuity contracts are purchased with retirement account funds and begin to pay out when the client reaches old age.
  • Because QLACs are fixed annuity products, they are vulnerable to inflation risk over time.
  • QLACs can offer significant protection against running out of retirement funds, especially if the client’s portfolio deteriorates due to bad market conditions.

In today’s environment, it’s no exaggeration to say that nearly every retired client should take the time to evaluate their inflation risk. Suddenly, the idea of outliving one’s retirement savings has become an extremely real issue, prompting many clients to revisit the idea of annuity products.

One type of annuity that may be newly attractive to clients who previously glossed over the product is the qualified longevity annuity contract, or QLAC. QLACs were introduced on the retirement planning scene in 2014 and have largely been marketed as a way for clients to protect against longevity risk while also minimizing the tax impact of ongoing required minimum distributions in retirement.

With inflation spiking, QLACs may also be poised to protect against the threat that rising costs pose for retirees in today’s market — meaning that it’s time for advisors to brush up on the product features.

QLACs: The Basics

A QLAC is an annuity that is purchased with retirement account funds and held within a traditional retirement plan — whether it’s a 401(k), 403(b) or traditional IRA. Annuity payments are deferred until the client reaches old age in order to provide retirement income security late in life (payments must generally begin no later than the month following the month when the client reaches age 85, although they can begin earlier). The annuity payments are guaranteed, meaning that the client will hedge against longevity risk in addition to reducing current RMDs.

QLACs are useful in retirement income planning generally because their value is excluded from the overall retirement account value when calculating the client’s RMDs once the client turns 72. This, of course, allows the client to reduce ordinary income tax liability once RMDs kick in by reducing the overall account value used to calculate required annual distributions.

Clients are limited to buying a QLAC with an annuity premium value equal to the lesser of (1) 25% of their account value or (2) $145,000 (as adjusted for inflation in 2022).

While many 401(k)s do not allow QLACs to be purchased within the plan, clients may be able to take an in-service distribution to roll funds over into an IRA (or simply transfer the funds to an IRA in a nontaxable transaction if they have already retired).

When it comes to the QLAC itself, clients have the option of choosing a joint payout option to benefit a surviving spouse or a lump-sum distribution to beneficiaries if the QLAC payments are never needed. Once QLAC payments begin, the amounts are subject to ordinary income tax just like any other traditional retirement account distribution.

Importantly, the client does not have to wait until reaching their required beginning date for RMDs to purchase the QLAC.

QLAC Disadvantages

Or course, each client should consider all of the angles before purchasing a QLAC. QLACs are fixed annuity products — meaning that the QLAC itself is vulnerable to inflation risk over time. Inflation protection riders may be available, but these features can be expensive and can reduce the client’s actual annuity payment.

The QLAC can, however, offer significant protection against running out of retirement funds in old age — especially if the client’s portfolio deteriorates due to bad market conditions or the client decides to withdraw more than anticipated earlier in retirement.

On the other hand, the funds in the QLAC cannot be used by the client to take advantage of favorable market conditions in the future.

There’s also a risk that the client won’t live as long as expected (although this risk can be mitigated by purchasing an annuity that also covers a spouse or that provides benefits for a fixed term regardless of when the client dies). Adding those protections, however, will reduce the client’s monthly QLAC payment accordingly.

Conclusion

QLACs might not be the ideal solution for every client, but for those who are worried about the impact of inflation on their retirement savings, the QLAC option can provide peace of mind while also providing a way to reduce RMDs early in retirement. 

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