Escape From the QLAC: IRS Clarifies Rules on Longevity Annuity Exchanges

What You Need to Know

Washington policymakers want to give retirees a way to maximize longevity insurance.
The problem: The QLAC framework locks people in.
Provisions in the new RMD regulations could let clients move some cash from one QLAC to another.

Policymakers in Washington are trying to get deferred income annuities off economists’ list of nice ideas and onto the list of products retirement savers really use.

The Setting Every Community Up for Retirement Enhancement (Secure) 2.0 Act of 2022 updated some rules on qualified longevity annuity contracts, or QLACs. The Internal Revenue Service is starting to add those rules to the regulations clients use to live their financial lives.

The IRS put the QLAC updates in the new required minimum distribution regulations, which came out in July, because QLACs give clients a way to defer a portion of their RMDs until they turn 85 and begin drawing income under the contracts.

Most of the regulation packet covers what happens when clients have money in ordinary 401(k) plan accounts or ordinary individual retirement annuities.

But some cover QLAC basics, and some are starting to get at the kinds of currently obscure QLAC features and limitations that may eventually spawn litigation, legislation, compliance webinars, and product and plan design creativity.

Some of the new RMD packet relates to a simple question: What happens when a client buys a QLAC, has issues with it, and wants to move the assets into another QLAC?

The gist of the IRS answer: Sure, a client can do that.

What it means: The framework for QLAC-to-QLAC exchanges is taking shape, one line of Federal Register content and IRS subregulatory guidance at a time.

Income annuity basics: Roughly $201 billion of the $211 billion of ordinary individual annuities sold in the United States in the first half of this year were deferred annuities, according to LIMRA survey data.

Clients put money into a deferred annuity. They accumulate contributions along with value increases linked to interest rates or the performance of investment indexes or investment funds. They can choose whether and when to tap the annuity for income.

An income annuity is different. A client puts cash into an income annuity and then pulls income out.

An immediate annuity begins paying benefits within about a year.

A deferred income annuity begins paying benefits starting at least a year after purchase.

The deferred income annuity blues: In theory, if Jane Doe, a 65-year-old retiree, puts money in a deferred income annuity immediately and waits until age 85 or later to begin drawing income, the fact that many of the other deferred income annuity holders have already died and 20 years of investment earnings can give the annuity the ability to pay out a large amount of income, for the rest of Jane Doe’s life, at a relatively low price.

Economists love deferred income annuities and believe they could be a powerful tool for solving the world’s retirement planning gaps. In the real world, many consumers are unfamiliar with deferred income annuities and reluctant to lock away their cash until they turn 85.

The insurers participating in LIMRA’s latest individual annuity sales survey reported just $2.9 billion in deferred income annuity sales in the first half of the year. That was 53% higher than the total for the first half of 2023 but amounted to only 1.5% of individual annuity purchases.

Economists write many papers analyzing the lack of retirement saver use of deferred income annuities.

Qualified longevity annuity contracts: Lawmakers and others designed QLACs in an effort to use modest tax incentives to get more retirement savers thinking about deferred income annuities.

To keep the cost of the tax breaks low, and guard against the possibility that the performance of QLACs could turn out to be disappointing, lawmakers have put tight constraints on QLAC use.

The IRS and its parent, the U.S. Treasury Department, posted QLAC regulations in 2014.

The regulations provided that a QLAC user could defer taking RMDs on the assets contributed to a QLAC. The maximum contribution was $125,000, or 25% of all of an individual’s savings held in individual retirement accounts, 401(k) plan accounts and other arrangements that qualify for federal retirement savings tax incentives.

Under the 2014 regulations, QLACs can’t have a stated cash value or investment-fund-like subaccounts, but they can be adjusted for inflation, according to an overview prepared in 2015 by Michael Finke.

Finke hoped the QLAC regulations would lead to a tsunami of deferred income annuity sales. Instead, they produced the current trickle.