The American system of retirement savings relies upon the concept of tax deferral. Contributions to 401(k) plans or Individual Retirement Accounts grow shielded from taxation to assist workers in banking up enough reserves to retire. But eventually, the tax man cometh and savers are required to begin taxable withdrawals at age 73.
Yet some people may not want or need to begin distributions at 73 if they have other resources available to cover their living expenses. For folks in that situation, there is a relatively unappreciated option for delaying distributions and simultaneously establishing a lifetime income stream. It is called a Qualified Longevity Annuity Contract, and in the right situation it can be a powerful planning tool.
One of the risks associated with retirement planning is the possibility that a retiree might outlive their savings and investments. This is called longevity risk and is an important factor to consider prior to and at retirement. Statistically, for a married 65 year old couple, there is a 50% chance that one will live past age 90. A deferred annuity can address this risk by setting up a cash flow sometime in the future, typically for the rest of the buyer’s lifetime, in exchange for a premium payment up front.
A “Qualified” Longevity Annuity Contract, referred to in the press as a QLAC, is a specific type of deferred fixed annuity available inside a traditional IRA account and some 401(k) and 403(b) plans. This kind of annuity allows an investor to purchase a future lifetime stream of income to begin on a date they specify any time up to age 85. Note that these are not variable annuities, which are effectively mutual funds tucked inside an insurance policy that often carry high fees and expenses and do not guarantee future income in the absence of a separate rider and additional fees.
The purchase price of a qualified longevity annuity is effectively removed from the account balance, reducing the amount of required minimum distributions and potentially delaying taxation until payments begin in the future. Once the income stream commences, distributions from the annuity are taxed as ordinary income.
Changes implemented in the SECURE 2.0 act of 2022 substantially enhanced the attractiveness of qualified longevity contracts in retirement accounts. For 2026, each taxpayer may contribute up to $210,000 to purchase a contract, or $420,000 per married couple. The new rules also eliminate the previous cap of 25% of the account value. Owners may now purchase up to the lifetime limit even if it consumes 100% of their IRA or company retirement account.
Annuitants (owners of the annuity who have begun receiving payments) generally have a few options for distributions. A single life option results in the highest periodic payouts but ends at the death of the owner. Joint life options allow for payments to continue to the surviving spouse but are lower each month. Some issuers offer return of premium options that allow beneficiaries to recover any residual surplus of premiums contributed over benefits paid out, in exchange for reduced monthly income.
Owners of the annuity are free to use the proceeds in any way they wish. The income stream could be a useful supplement to Social Security or be allocated to cover recurring premiums for long term care or life insurance. The security of a guaranteed paycheck in the out years might also allow the investor to assume more risk elsewhere in their portfolio for future growth.
Part or all of the income may also be designated to charities in the form of a Qualified Charitable Distribution, excluding the contribution from income tax if the distribution is paid directly to the charity within the allowable limits, currently $222,000 per couple filing jointly.
Annuitants can also purchase multiple contracts with different income starting dates, a concept known as laddering. This could be useful for retirees with a finite stream of payments like a pension plan distribution that pays out for a certain number of years and then stops.
A qualified longevity contract can be purchased by anyone with a traditional pre-tax IRA account (not a Roth). Since their creation in 2014, they have also been allowed as an option in defined contribution plans like 401(k) and 403(b) plans, but so far employers have been reticent to add them. Because plan sponsors (employers) have a fiduciary duty of due diligence, and since there is a small but non-zero possibility of issuer bankruptcy, only around 5% of plans currently provide for them. However, many plans allow so-called in-service withdrawals of a portion of a 401(k) that can be rolled over to an IRA account. The owner could then purchase a qualified contract inside their rollover IRA account.
By delaying a portion of the required distribution starting at age 73, a retiree might avoid being bumped into a higher tax bracket which could trigger additional Medicare surcharges that kick in above certain income thresholds. And as an additional consideration, interest rates are still relatively attractive today, which translates into a higher cash flow stream once payments begin.
As with most decisions in life, the choice of a longevity annuity comes with limitations that must be considered. The decision is irrevocable; once the contract is finalized it generally cannot be undone, although federal rules require a “free look” period of 10 to 90 days during which the contract may be cancelled. Also, the assets placed into the annuity are no longer available for investment in other growth assets. And the choice of distribution options should be carefully weighed. For instance, a single life annuity goes away when the owner passes, but other options reduce the income payments.
A qualified longevity annuity contract is not appropriate for everyone, as one must have sufficient assets and current income from other sources to carry over until payments begin. In the right situation, especially given recent enhancements, a longevity annuity can be a powerful planning tool and help provide additional peace of mind.