Say you've been a prudent retirement saver, and you're approaching age 70. You'll soon have to begin taking minimum distributions from your IRA or 401(k), but your other investments are giving you all the income you need. You'd rather not drain your IRA, because you worry about running short when you're older and health costs increase.
Is there anything you can do?
Since 2014, you have been able to purchase a qualified longevity annuity contract. This product, abbreviated as QLAC and pronounced "cue-lack," was approved by the IRS then to allow savers to defer distributions from a portion of their assets in IRAs or employer-sponsored qualified plans until as late as age 85.
QLACs essentially provide a way to customize minimum required distributions, which otherwise automatically begin at age 70.5. They can help reduce current taxes, since savers don't have to pay taxes on withdrawals from a QLAC until later. And they can reassure savers who worry that Social Security won't be enough to cover late-life healthcare costs.
The IRS places some significant limitations on QLACs. For one thing, once you put money into a QLAC, you can't change your mind. "The purchase is irrevocable," explains Bill Johnson, president of Fidelity Investments Life Insurance.
For another, you can't put your whole IRA into a QLAC. For individuals, the cap is $125,000, or 25% of IRA or qualified plan assets, whichever is smaller. Married couples have a cap of $250,000.
Also, a QLAC's ability to save on taxes long-term is not guaranteed. Once withdrawals from the QLAC begin, they will be larger than if they'd started at age 70.5. So that means the later tax bill could actually be higher.
Also, you can't defer payments forever. Age 85 is the latest you can wait before beginning distributions from a QLAC. And most don't specify waiting even that long to start taking distributions, Johnson adds, taking them beginning at 80 or even 75.
The reason people don't wait until the maximum age is that you need to live long enough to make the QLAC pay off, says Katherine Kraeblen, a certified financial planner with The PNC Financial Services Group in Raleigh, N.C. "You don't want to die too soon so that you don't get the money back," she says.
For that reason, longevity calculations are an essential starting point for any QLAC purchase decision, Kraeblen says. Before buying a QLAC, savers need to examine longevity in their family and their own health. A typical 65-year-old man has a 50% chance of living to 85, according to Fidelity, but this will vary by individuals.
QLACs are generally purchased by people nearing age 70, although some customers past that age and a few in their early 60s also purchase them, Johnson says. While $125,000 is the individual maximum, Fidelity sells QLACs as small as $10,000. The company provided a quote showing that a 70-year-old male purchaser of a $125,000 annuity deferring payments until age 85 would receive $3,563 per month.
QLACs are still new enough that not many are using them, Johnson says. However, if average retirement ages creep up closer to 70, more people will invest in QLACs, he adds.
People who work past age 70 represent one group likely to want to avoid taking money out of an IRA to pay current bills, while making sure they will have it later on. For them, a QLAC could be a solution. "In effect," says Kraeblen, "you're taking your IRA and deferring it a big longer."