Qualified Longevity Annuity Contracts (QLACs) – Definition & Detailed Explanation – Elderly Legal and Financial Planning Glossary

I. What are Qualified Longevity Annuity Contracts (QLACs)?

Qualified Longevity Annuity Contracts (QLACs) are a type of annuity that provides guaranteed income for a specific period of time, typically starting at an advanced age, such as 80 or 85. QLACs are designed to help individuals protect against outliving their retirement savings by providing a steady stream of income in their later years. These annuities are considered “qualified” because they meet specific requirements set by the Internal Revenue Service (IRS) to receive favorable tax treatment.

II. How do QLACs work?

When an individual purchases a QLAC, they make a lump-sum payment to an insurance company in exchange for a promise to receive regular income payments starting at a specified future date. The income payments from a QLAC are typically guaranteed for life, providing a level of financial security in retirement. The amount of income received is based on factors such as the age at which payments begin, the amount of the initial premium, and the terms of the contract.

III. Who is eligible to purchase a QLAC?

To be eligible to purchase a QLAC, an individual must meet certain criteria set by the IRS. These criteria include age restrictions, contribution limits, and other requirements. Generally, individuals must be at least 70 ½ years old to purchase a QLAC, and the maximum amount that can be invested in a QLAC is limited to a percentage of the individual’s retirement account balance, up to a certain dollar amount.

IV. What are the benefits of investing in a QLAC?

There are several benefits to investing in a QLAC. One of the primary benefits is the guaranteed income stream that a QLAC provides, which can help individuals protect against the risk of outliving their retirement savings. Additionally, QLACs can help individuals manage their required minimum distributions (RMDs) from retirement accounts, as the income from a QLAC is not subject to RMD requirements until payments begin. QLACs also offer tax advantages, as the income received from a QLAC is taxed at the individual’s ordinary income tax rate.

V. How are QLACs taxed?

The tax treatment of QLACs is favorable compared to other types of annuities. The income received from a QLAC is taxed at the individual’s ordinary income tax rate, similar to other retirement account distributions. However, because the income from a QLAC is deferred until payments begin, individuals may be in a lower tax bracket when they start receiving payments, potentially reducing their tax liability. Additionally, a portion of the income received from a QLAC may be considered a return of the individual’s original investment and therefore not subject to income tax.

VI. What are the potential drawbacks of QLACs?

While QLACs offer several benefits, there are also potential drawbacks to consider. One drawback is the lack of liquidity, as the funds invested in a QLAC are typically locked in for the duration of the contract. This means that individuals may not have access to the full amount of their investment if they need it for unexpected expenses or emergencies. Additionally, the income payments from a QLAC may not keep pace with inflation, potentially reducing the purchasing power of the payments over time. Finally, there are fees and expenses associated with QLACs, which can impact the overall return on investment. Individuals considering investing in a QLAC should carefully weigh these factors before making a decision.