Many retirees worry about running out of money in their later years. One solution is to hoard money (spend less) today because you might live beyond the average life expectancy. The problem with that solution is that it causes everyone to live below his possible standard of living even though not everyone will live long enough to have the problem.
The insurance industry’s solution: For a lump sum payment that is relatively small while you are only in your 50s or 60s, buy an annuity now that doesn’t start paying out until you reach your mid 80s. Such a “longevity annuity” enables you to spend more during your “young old years” without worrying that you will run out of money if you live too long. But that type of annuity could not, until now, be purchased inside a traditional IRA (or other defined contribution/individual account plan, such as a 401(k) plan) because of the rule that payments under a plan-owned annuity contract must begin by the required beginning date (RBD) (generally approximately age 70½).
The IRS has ridden to the rescue. Under proposed regulations issued in 2012, as modified and finalized effective July 2, 2014, up to 25 percent of the participant’s account balance (but not more than $125,000) can be invested in a “qualified longevity annuity contract” (QLAC) without violating the minimum distribution rules.
Definition of a QLAC
Under the IRS Regulations, a QLAC must begin its payments no later than the first day of the month next following the 85th anniversary of the participant’s birth, and must otherwise satisfy all of the requirements that are otherwise applicable to annuitized defined contribution plans. The QLAC may not provide cash surrender rights or similar features; cannot be indexed to variable market performance such as the S&P 500 index; and must limit death benefits.
Dollar and Percentage Limits on QLAC Purchases
The amount paid for QLACs may not exceed the lesser of $125,000 or 25 percent of your combined IRA account balances. A participant can buy multiple QLACs in his/her traditional IRA(s) provided the cumulative total premiums paid do not exceed these limits. The $125,000 amount will be adjusted upwards for inflation starting in 2015, however.
The 25% limitation is applied to the total account balance (including the value of any QLAC). The IRS treats all traditional IRAs that you own as a single account for applying this limit, just as required minimum distributions taken from one traditional IRA can satisfy the distribution requirement with respect to other traditional non-inherited IRAs owned by the same individual.
The limitations on purchases of longevity annuities do not apply to Roth IRAs during the owner’s life. That’s because there is no lifetime minimum distribution requirement applicable to a Roth IRA, therefore, buying an annuity that does not start payments until much later than age 70½ is “not a problem” for a Roth IRA.
Longevity annuities held in a Roth IRA are not considered QLACs and do not count when applying the 25 percent/$125,000 limit on QLAC purchases in the participant’s traditional IRA.
Rules Regarding QLAC Death Benefits
Since a QLAC is supposed to be insurance against living “too long,” it makes no sense for the QLAC to provide a death benefit. The cost of providing a death benefit must necessarily reduce the true “longevity insurance” the contract can provide. But human nature being what it is, people only want to buy this product if some kind of death benefit applies, so the IRS regulation permits certain limited death benefits. In general, the permitted death benefits must either be in the form of a “permitted” survivor annuity, or, alternatively, the contract can provide a “return of premium” guarantee-type death benefit in lieu of any survivor annuity.
If the participant’s surviving spouse is the sole beneficiary, the contract can provide a life annuity to the surviving spouse provided the annuity payments do not exceed the annuity payments the participant would have received.
If the participant’s surviving spouse is not the sole beneficiary, the contract can provide a life annuity to the surviving beneficiary. If the beneficiary is the same age as, or older than, or not more than two years younger than, the participant, the maximum annuity is the same annuity the participant would have received. If the beneficiary is more than two years younger than the participant, the amount of the maximum survivor annuity is reduced per a table in the regulation.
You may see a plethora of QLACs in the near future being issued by the large insurance firms. For those that are concerned that their IRAs may not last as long as they do, it might be something to look into.
©2014 Craig R. Hersch