Turning age 70½ is an important milestone if you have a traditional IRA or 401(k). That's when you must begin taking mandatory minimum yearly withdrawals, known as minimum required distributions (MRDs), or sometimes referred to as required minimum distributions (RMDs), from these accounts.1 But what if you don’t need that money for current living expenses and would prefer to receive guaranteed lifetime income later in retirement?
Fortunately, the U.S. Treasury Department issued a new rule creating Qualified Longevity Annuity Contracts (QLACs) in 2014. QLACs allow you to use a portion of your balance in qualified accounts—like a traditional IRA or 401(k)—to purchase a deferred income annuity (DIA2) and not have that money be subject to MRDs starting at age 70½.
- Read Viewpoints: "Create future retirement income."
What is a QLAC?
A QLAC is a DIA that can be funded only with assets from a traditional IRA3 or an eligible employer-sponsored qualified plan such as a 401(k), 403(b), or governmental 457(b). At the time of purchase, you can select an income start date up to age 85, and the amount you invest in a QLAC is removed from future MRD calculations.
"Annuities are the solution for many individuals seeking guaranteed lifetime income. But they aren’t one size fits all," explains Roy Benjamin, vice president of product development and an actuary at Fidelity. "Until recently, funding an annuity using tax-deferred savings like an IRA or 401(k)—while deferring income until later in retirement—was a challenge."
QLACs address one of the biggest concerns among individuals in retirement: making sure they don’t outlive their savings. After all, more than 40% of American workers aren’t confident they’ll have enough money to maintain their standard of living through retirement, according to a recent survey by the Employee Benefit Research Institute.
A QLAC delivers a guaranteed4 stream of lifetime income beginning on a date you select. For instance, you may purchase a QLAC at age 65 and have your payouts begin at age 75. Typically, the longer the deferral period, the higher your payout will be when you’re ready to start receiving income payments.
Previously, funding a DIA with qualified funds from an IRA posed a problem: IRAs and other tax-deferred plans such as 401(k)s include MRD rules that require you to begin taking withdrawals after you reach age 70½. “That changed with QLACs, which allow you to have more flexibility over when you choose to start taking income,” says Benjamin. There are rules, however, about how much money you can use to fund a QLAC. Currently, you’re subject to two limitations: Total lifetime contributions cannot exceed $125,000, across all funding sources, and QLAC contributions from a given funding source cannot exceed 25% of that funding source's value.5
How a QLAC can create steady, later-in-life income
Let’s say you own one or more IRAs with a total balance of $200,000 as of December 31 of the previous year. You would be limited to using $50,000, which is 25% of $200,000 and is less than $125,000, to fund the QLAC. [Some 401(k) plans offer access to QLACs; check with your employer or plan sponsor to learn more about the rules for your plan.] But if your total IRA balance is worth $500,000 or more, the maximum you can contribute to a QLAC is $125,000. Keep in mind that in both cases the money that remains in your IRA or 401(k) is still subject to MRDs.
Use our interactive widget below and adjust the green options in the white box to match your situation:
To make it easier to understand how a QLAC might fit into your retirement income plan, enter your personal information in the interactive widget. It assumes you’re age 70 and investing $125,000 in a QLAC. You can personalize whether you’re male, female, or purchasing as a couple. Then you can adjust when you want to start receiving income, as early as age 75 or as late as age 85. Finally, you can see what the amount of total lifetime payments would be if you lived to age 90, 95, or 100.
To provide a working example, let’s assume a woman is approaching age 70½ and does not need her full MRD to cover current expenses. By investing a portion of her traditional IRA assets in a QLAC at age 70, she would not have MRD requirements on the assets invested in the QLAC, and she would receive guaranteed lifetime income starting at a date of her choice, up to age 85. During the deferral period, she would rely on Social Security, MRDs from the remaining money in her IRA, withdrawals from investments, and other income, such as part-time work or a sale of a business, to cover expenses. If she invests the $125,000 in a QLAC and defers to age 80, her guaranteed income would be $14,825 a year no matter what happens over time, and she would receive a total of $222,373 in payments if she lived to age 95—or more if she lived longer.
Purchasing an annuity can be complicated, with many kinds to choose from. "The good news is that QLACs aren't complex," says Benjamin. "The restrictions within the U.S. Treasury Department's QLAC rule make them easier to understand."
Consider these options: Single or joint life? If you are married, you can choose a joint contract, which will provide income payments that will continue for as long as one of you is alive. Choosing a joint contract may decrease your income payments—compared with a single life contract—but may also provide needed income for your spouse should you predecease him or her.
Should you include a cash refund death benefit? When purchasing a QLAC, the income lasts for your lifetime (joint contracts pay income for you and your spouse, as long as one of you is alive). You may also want to consider adding a cash refund death benefit. This provides for a lump sum paid to your beneficiaries if your lifetime payments do not exceed the dollar amount you invested in the QLAC. While a contract without the cash refund death benefit may provide higher income payments, it does not include a death benefit and, therefore, no beneficiary protection for your heirs. Compare QLAC options, including a cash refund death benefit, with Fidelity’s Guaranteed Income Estimator tool.
When do you want income to start? A QLAC should be part of a broader income plan, to help ensure that your essential expenses like food, health care, and housing are covered during retirement—ideally with lifetime income sources such as Social Security, a pension, or lifetime annuities. Your deciding on an income start date will depend on how this income stream will best fit into your overall plan. Here are some hypothetical examples of how someone might choose an income start date:
- A 70-year-old retiree with an existing income stream that will stop at age 75 (for example, proceeds end from the sale of a business, she stops working part time, inheritance income ceases) might start income at age 76 for her QLAC to replace the income that is ending.
- A couple in their late 60s might like to include an income stream that begins at age 80 or 85 as part of their overall plan, to help cover higher anticipated health costs later in retirement.
- A couple at age 65 might be comfortable taking withdrawals from their investment portfolio to cover their expenses at the beginning of their retirement, but they are concerned about the potential need for it to last 30 years or more. They might consider a QLAC that provides lifetime income starting at age 85 to help address these concerns.
Can I change the income start date? For contracts that include a cash refund death benefit, you typically have the ability to change the date by up to five years in either direction (subject to an age-85 maximum). For example, if you initially select age 78 as your income start date, you could subsequently change this date to anytime from age 73 to age 83. Of course, the amount of income that you will receive will typically be adjusted to a lower amount if you decide to change the date to an earlier age, and a higher amount if you change the date to a later age.
Should I consider a QLAC?
Benjamin notes that the decision to purchase a QLAC is a personal one and should take into account your family’s needs and financial goals. For instance,, you may not want to take MRDs on the entire pretax balance of your IRA if doing so would provide you with more income than you need. But will your financial standing be as strong 20 or even 10 years from now? "If that's a concern, a QLAC would allow you to start income later, when you really might need it," explains Benjamin.
In terms of when to make a decision about purchasing a QLAC, Benjamin suggests weighing the options before reaching age 70½: "While the QLAC rule allows you to purchase after age 70½, it's a good decision to make before you get to that moment of truth where you need to start taking your MRDs."
Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.
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