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Robert Bloink and William H. Byrnes

Retirement Planning > Saving for Retirement

Secure 2.0 Makes QLACs More Appealing

By Robert Bloink By William H. Byrnes

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What You Need to Know

  • The QLAC is a type of deferred annuity purchased with retirement plan dollars to provide income security late in life.
  • However, the value of a QLAC strategy was limited by the rules governing these types of contracts.
  • Secure 2.0 has expanded the rules governing these types of longevity insurance contracts, increasing their value.

Qualified longevity annuity contracts, or QLACs, were first introduced into the market in 2014. The concept is fairly straightforward. The QLAC is a type of deferred annuity purchased with retirement plan dollars to provide income security late in life. As an incentive, any QLACs purchased within the contract are not counted when determining the account value at year-end for required minimum distribution calculation purposes.

On the other hand, the value of a QLAC strategy was limited by the rules governing these types of contracts. The Setting Every Community Up for Retirement Enhancement (Secure) 2.0 Act changed the game and expanded the rules governing these types of longevity insurance contracts, increasing the value of these contracts and providing clarity for tax years 2023 and beyond.

QLACs: The Basics

A QLAC is a type of deferred annuity purchased with retirement plan dollars. Annuity payments are deferred until the client reaches old age (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 beneficial in that the value of the QLAC is excluded when the owner calculates RMDs. 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.

Under the original rules governing QLACs, taxpayers were limited to purchasing a QLAC with an annuity premium value equal to the lesser of:

  • 25% of their account value, or
  • $145,000 (as adjusted for inflation in 2022).

The 25% limit was applied separately to separate employer plans, but in aggregate when it came to IRAs.

Taxpayers also 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.

Secure 2.0 Expansion

The Secure 2.0 Act eliminated the rule that previously limited the value of a QLAC to 25% of the account’s value. Further, the law modified the previous rule that limited the value of the QLAC to $125,000 by raising the cap to $200,000 (the $200,000 limit will be indexed for inflation in future years).

The law also provides for a “free-look period” of up to 90 days, during which the taxpayer can rescind the purchase of the QLAC without penalty.

The new law clarified that if the QLAC was purchased with joint and survivor annuity benefits for the individual and a spouse, and assuming that the contract was permissible under regulations in place at the time of purchase, a divorce occurring after the original purchase and before annuity payments begin will not affect the permissibility of the joint and survivor annuity benefits. Further, the divorce will not affect any other benefits under the contract (or require any adjustment to the amount or duration of the benefits).

That is the case provided that a qualified domestic relations order (QDRO):

  • provides that the former spouse is entitled to the survivor benefits under the contract,
  • provides that the former spouse is treated as a surviving spouse for purposes of the contract,
  • does not modify the treatment of the former spouse as the beneficiary under the contract who is entitled to the survivor benefits, or
  • does not modify the treatment of the former spouse as the measuring life for the survivor benefits under the contract.

Conclusion

The latest update on the QLAC rules could significantly increase the appeal of these types of longevity insurance contracts going forward — and, depending on the client’s circumstances, reduce RMD obligations in future years.

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Robert Bloink

William H. Byrnes

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