One of the most attractive aspects of adding an annuity to any retirement portfolio is the peace of mind that comes with guaranteed income in retirement. Two of the more popular annuity products include deferred and longevity annuities, and while they share several similar characteristics, they are very different options, as described in a recent article from ThinkAdvisor.
A deferred annuity includes an initial waiting period before the contract can be annuitized, typically between one and five years. During that period, the contract’s cash value is usually liquid and available. After the waiting period is over, the contract can be annuitized, but isn’t required to be until the contract’s maximum maturity age is reached. A longevity annuity is different in that generally the funds can not be accessed during the deferral period, and does not allow the contract to be annuitized until the owner reaches a predetermined age, usually around 85.
With both options, most purchasers buy an annuity product with the idea of not beginning payouts until old age. The major difference between the two is the ability to begin payments at an earlier date with a deferred product. Why would anyone choose a longevity annuity then? Typically, payments with a longevity annuity are larger. Much larger. Most taxpayers who purchase a longevity annuity do so to protect themselves from the risk of outliving their retirement assets. The longevity annuity ends up acting as a safety net, or insurance for expenses typically incurred at this advanced age.
In an effort to encourage the purchase of annuities, a product referred to as a qualified longevity annuity contract, or QLAC, has been developed. A QLAC is a type of deferred annuity product that meets certain IRS requirements and is usually purchased before retirement to be used once the taxpayer reaches old age. The key advantage offered with a QLAC involves required minimum distributions (RMDs). With a traditional deferred annuity, the value of the contract is included in determining the RMDs, but the IRS’ rules allow the value of a QLAC to be excluded from the account value for purposes of calculating these figures. Including the value of a QLAC in determining RMDs might result in the taxpayer being forced to begin annuity payouts earlier than anticipated, but by excluding it, the IRS determined that the goal of providing taxpayers with predictable retirement income late in life was more achievable.
There are some stipulations on this offer however. The amount the taxpayer can invest in a QLAC and exclude from the RMD calculation is limited to 25% of the taxpayer’s retirement account value, or $125,000. Also, to qualify as a QLAC, the annuity contract must provide that payouts begin no later than the first day of the month following the month in which the policyholder reaches age 85. Variable annuities, indexed annuities and similar products may not qualify as QLACs. Further, a QLAC cannot provide any commutation benefit, cash surrender value or similar benefit.
A qualified longevity annuity contract may be held in a qualified defined contribution plan, like a 401(k), IRC Section 403 plans, traditional IRAs and individual retirement annuities under Section 408, and eligible IRC Section 457 governmental plans. However, an annuity purchased under a traditional IRA cannot qualify as a QLAC. If a QLAC is bought under a traditional IRA or other qualified plan and later rolled over or converted to a Roth IRA, the annuity will not be treated as a QLAC any longer.
While the rules that govern qualified longevity annuity contracts may be considered lengthy and complex, the tax benefits are worth the time to learn about them. Consulting with a trusted financial advisor who is very familiar with these products is always recommended when considering the addition of an annuity product to your retirement portfolio.
Written by Rachel Summit