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What is a Qualified Longevity Annuity?

What is a Qualified Longevity Annuity?

Last year, the Treasury Department and the Internal Revenue Service (IRS) made it more advantageous for people to own deferred annuities in their qualified retirement plans.

A new rule allows account holders to exclude certain annuity contracts from their retirement plan account balance. These contracts, called Qualified Longevity Annuities (QLAs) allow you to defer retirement income longer than IRS rules used to permit.

Qualified plans and annuities that grow tax deferred are subject to Required Minimum Distributions (RMDs). To prevent account holders from earning tax deferral for as long as they wish, the IRS requires minimum distributions starting no later than when the account owner reaches age 70 1/2. The distribution amount is based on the account’s year-end value and a formula calculated by the IRS.

This used to limit a person’s ability to own long-term annuities in their 401(k) or IRA because the product’s surrender period would conflict with the RMD. For example, a person age 61 or older could not buy a 10-year deferred annuity within a qualified plan because the insurance company would have assessed a withdrawal charge during that 10-year period, while the IRS dictated a minimum withdrawal starting at age 70 1/2, or else it assessed a penalty. Therefore, older individuals could only buy short-term deferred annuities and could not benefit from the contract accumulating value for a long-term period.

Now, investors can allocate a certain amount of their 401(k) or IRA balance to a Qualified Longevity Annuity without worrying about violating the RMD rule. A QLA is a type of annuity with a longer deferral period, in which income can begin as late as age 85 and continue for the owner’s lifetime.

Benefits of QLAs

This rule benefits retiree in several ways. First, it gives them a more favorable option to turn their retirement plan assets into guaranteed lifetime income. Second, because they can defer income longer than age 70 1/2, retirees can accumulate a larger account value value.

Third, the amount of lifetime income they receive depends not only on the account value at the time payments begin, but also their age; the older one is when lifetime payment begins, the more their income will be.  A longevity annuity without the RMD restriction means retirees can wait up to 15 years longer than the RMD age to start income.

For example, one online annuity calculator shows that a 65-year-old male using $125,000 of his qualified plan to purchase a QLA and deferring income to age 80 could receive about $2,350 in monthly income for life. The same individual who purchased a regular annuity inside a qualified plan and started taking RMDs at age 70 1/2 could only receive $841 a month in lifetime income.

QLA Rules

The Treasury Department’s rule for QLAs allow you to invest up to 25 percent of your IRA or 401(k) account value, up to a maximum of $125,000 in a QLA without having to take an RMD on that money. Depending on the plan sponsor and the annuity choices available, investors can make a lump sum premium payment or in increments through salary deferral in the case of a 401(k) or other employer sponsored plan. If you mistakenly invest more than allowable you can correct the error without penalty.

The rule also allows a return of premium feature in the event you pass away before receiving income in an amount equal to the premium paid. This money would be returned to the qualified plan account. The regulations also permit a life annuity payable to a designated beneficiary after the annuity owner’s death.

The tax rules for QLAs are the same as with regular annuities purchased within a qualified plan. One potential advantage of purchasing an annuity inside a qualified plan is doing so with pre-tax money. Contributions to a qualified plan, from you which you could buy an annuity, are tax deductible. Annuity income deriving from a 401(k) or IRA will be taxed as regular income as with any distribution from a qualified plan.