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 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.