QLACs Explained: The Treasury's Solution to Outliving Your Money

One of the biggest fears people have about retirement is running out of money. You save for decades, build up your nest egg, and then hope it lasts as long as you do. But what happens if you live to 90 or 95? What if your savings simply cannot keep up? The U.S. Treasury asked the same question, and in 2014, it introduced a new type of annuity designed specifically to solve this problem: the Qualifying Longevity Annuity Contract, or QLAC.

A QLAC is a deferred income annuity that you buy with money from a qualified retirement account like a traditional IRA or 401(k). Instead of paying you right away, it waits until you reach an older age, often 80 or 85, and then sends you guaranteed monthly checks for the rest of your life. Think of it as longevity insurance. You are paying a premium now to guarantee you will have income later, no matter how long you live.

In this guide, we will explain how QLACs work, who they are best suited for, how much you can invest, and what the Treasury rules say about using them inside your retirement accounts. Whether you are already retired or still planning, understanding QLACs can help you build a more secure financial future.

What Is a QLAC and Why Did the Treasury Create It?

Before QLACs existed, there was a problem. If you wanted to use money from your IRA or 401(k) to buy a deferred annuity that started payments at age 85, the IRS rules on required minimum distributions got in the way. The IRS requires you to start taking money out of your traditional retirement accounts at a certain age (currently 73, rising to 75 in 2033). The full value of a deferred annuity was included in the account balance used to calculate those distributions, even though you could not actually access that money yet.

The Treasury Department fixed this by creating QLAC rules in July 2014 under Treasury Decision 9673. These rules allow you to exclude the value of a qualifying longevity annuity from your RMD calculations. In other words, the money you put into a QLAC does not count when the IRS figures out how much you must withdraw each year. This was a big deal because it made deferred annuities practical inside retirement accounts for the first time.

The goal was simple: give Americans a tool to protect themselves against the risk of living longer than their savings can support. By allowing people to set aside a portion of their retirement funds in a QLAC, the Treasury created a government-sanctioned way to buy guaranteed lifetime income that kicks in when you need it most, in your eighties and beyond.

How QLACs Work: A Step-by-Step Overview

Understanding how a QLAC works is straightforward once you break it into steps. Here is what the process looks like from start to finish.

First, you decide how much of your IRA or 401(k) balance you want to allocate to a QLAC. Under the SECURE 2.0 Act, the maximum is $200,000 (indexed for inflation). You then purchase the QLAC from an insurance company that offers this product. The money stays inside your retirement account, but it is now held by the insurance company in the form of an annuity contract.

Second, you choose when you want payments to begin. You can pick any age from the time of purchase up to age 85. The longer you wait, the higher your monthly payment will be. This is because the insurance company has more time to earn returns on your premium, and statistically, it will be paying you for a shorter period.

Third, during the deferral period (the years between when you buy the QLAC and when payments start), the QLAC amount is excluded from your RMD calculations. This reduces your taxable income each year because your required withdrawals are smaller.

Fourth, when you reach the payout age you selected, the QLAC begins sending you guaranteed monthly income for the rest of your life. These payments are taxable as ordinary income, just like any other distribution from a traditional IRA or 401(k).

QLAC Contribution Limits: What the Law Allows

When the Treasury first introduced QLACs in 2014, there were two caps on how much you could invest. You were limited to the lesser of $125,000 or 25 percent of your total retirement account balance. These dual limits made QLACs less attractive for some people, especially those with large retirement balances who wanted to protect more of their savings.

The SECURE 2.0 Act, signed into law in December 2022, made a significant change. It eliminated the 25 percent cap entirely and raised the dollar limit to $200,000, adjusted for inflation. This means you can now put up to $200,000 into a QLAC regardless of how large or small your retirement account balance is. The $200,000 limit applies across all of your qualified accounts combined. So if you have an IRA and a 401(k), the total QLAC purchases across both accounts cannot exceed $200,000.

It is worth noting that Roth IRAs are generally not good candidates for QLACs. Since Roth IRAs no longer have required minimum distributions for the original owner (thanks to the SECURE 2.0 Act), the RMD exclusion benefit of a QLAC does not apply. You would lose the tax-free growth benefit of a Roth by locking the money into a QLAC.

The RMD Advantage: How QLACs Lower Your Tax Bill

One of the most appealing features of a QLAC is how it interacts with required minimum distributions. Under IRS rules, once you reach age 73 (or 75 starting in 2033), you must begin withdrawing a minimum amount from your traditional IRA and 401(k) each year. These withdrawals are taxed as ordinary income. The larger your account balance, the larger your RMD, and the more taxes you owe.

Here is a simple example. Suppose you have $800,000 in your traditional IRA at age 73. Without a QLAC, your entire balance is used to calculate your RMD. With a QLAC worth $200,000, only $600,000 is used in the calculation. Your RMD is 25 percent smaller, which means you pay less in taxes that year. Over a decade or more of reduced RMDs, the tax savings can add up to thousands of dollars.

Lower RMDs can also help you stay below income thresholds that trigger higher Medicare premiums (known as IRMAA surcharges) or cause more of your Social Security benefits to become taxable. For many retirees, this cascading tax benefit is just as valuable as the guaranteed income the QLAC provides later.

Who Should Consider a QLAC?

QLACs are not the right fit for everyone, but they can be extremely useful for certain people. Here are the profiles that benefit most.

• People with a family history of longevity. If your parents or grandparents lived well into their nineties, a QLAC gives you a safety net of guaranteed income in your later years when other assets may be depleted.
• Retirees who want to reduce RMDs. If you do not need all of your RMD income and want to lower your tax burden, a QLAC lets you shelter up to $200,000 from RMD calculations.
• People worried about market crashes in retirement. Since QLAC payments are guaranteed by the insurance company, they are not affected by stock market downturns. This gives you a floor of income that does not depend on how your investments perform.
• People who already have enough income for their sixties and seventies. If Social Security, pensions, and other savings cover your needs in early retirement, a QLAC lets you earmark funds specifically for your eighties and beyond.

QLAC vs. Other Types of Annuities

QLACs are a specific subset of deferred income annuities, and it helps to understand how they compare to other common annuity types.

QLAC vs. Immediate Annuity

An immediate annuity starts paying you within 12 months of purchase. A QLAC delays payments, often for 10 to 20 years. Because of this delay, a QLAC can provide much higher monthly payments per dollar invested compared to an immediate annuity. However, you take on the risk that you might not live long enough to collect. An immediate annuity is better if you need income right now. A QLAC is better if you want to insure against outliving your money in your eighties and nineties.

QLAC vs. Fixed Deferred Annuity

A fixed deferred annuity accumulates value at a guaranteed interest rate and lets you withdraw money or annuitize later. Unlike a QLAC, a regular deferred annuity inside an IRA does not get excluded from your RMD calculations. A QLAC has the unique Treasury-approved RMD exclusion, which makes it a better choice for people who specifically want to reduce their required distributions and defer income to later years.

QLAC vs. Variable Annuity

Variable annuities invest in sub-accounts similar to mutual funds, and your returns depend on market performance. QLACs are fixed-income products with guaranteed payouts. A QLAC will not give you the upside of a strong stock market, but it also will not lose value in a downturn. For the specific purpose of guaranteeing late-life income, a QLAC offers more certainty.

Potential Drawbacks to Keep in Mind

Like any financial product, QLACs come with trade-offs. It is important to consider the downsides before committing your money.

• Illiquidity. Once you buy a QLAC, you generally cannot access those funds until the payout date. If you face an unexpected expense, that money is locked away. Make sure you have enough liquid savings to cover emergencies before buying a QLAC.
• No inflation adjustment (usually). Most QLACs pay a fixed dollar amount. If inflation runs high between the time you buy and the time payments start, the purchasing power of those payments may be reduced. Some insurers offer inflation riders, but they come at the cost of a lower initial payment.
• You could die before receiving payments. If you buy a QLAC at age 65 with payments starting at 85 and you pass away at 78, you may never receive a single payment. A return-of-premium death benefit rider can protect your heirs, but it is not included in every contract by default.
• Insurer credit risk. QLAC payments are guaranteed by the insurance company, not by the federal government. If the insurer goes bankrupt, your payments could be at risk, though state guaranty associations provide some protection, typically up to $250,000 in annuity benefits.

How to Buy a QLAC: The Process

Buying a QLAC involves several steps, but the process is not overly complicated. Here is what to expect.

1. Work with a licensed insurance agent or financial advisor who is familiar with QLACs. Not all agents sell them, and not all insurance companies offer them.
2. Decide how much you want to invest, up to the $200,000 limit. Your agent can help you determine the right amount based on your overall retirement plan.
3. Choose your payout start date (up to age 85) and any optional features like a return-of-premium death benefit or inflation adjustment rider.
4. Complete the application and authorize the transfer from your IRA or 401(k) custodian to the insurance company. The funds move directly from one custodian to another, keeping the transaction inside the retirement account.
5. Receive your contract confirmation. Keep this document in a safe place, and inform your beneficiaries about the QLAC so they know it exists.

SECURE 2.0 Act Changes That Affect QLACs

The SECURE 2.0 Act, passed at the end of 2022, made several changes that directly benefit QLAC buyers. Understanding these updates is important because they make QLACs more flexible and accessible than they were under the original 2014 rules.

The most significant change was the elimination of the 25 percent cap. Under the old rules, even if you had $1 million in your IRA, you could only put $125,000 (the lesser of $125,000 or 25 percent of your balance) into a QLAC. Now, anyone can invest up to $200,000 regardless of their account size. This is especially helpful for people with smaller retirement balances who want to allocate a larger share to guaranteed income.

The SECURE 2.0 Act also allowed QLACs to include a return-of-premium death benefit without it disqualifying the contract. Previously, certain death benefit structures could cause the contract to lose its QLAC status. The new rules clarify that an insurer can promise to return your premium to your beneficiaries if you die before collecting that amount in payments, and the contract will still qualify as a QLAC.

Additionally, the Act introduced a correction mechanism for excess QLAC contributions. If you accidentally contribute more than the allowed limit, you can now fix the error without the entire contract losing its QLAC status. Before this change, an excess contribution could have disqualified your QLAC entirely, creating a tax headache.

Real-World Example: How a QLAC Could Work for You

Let us look at a hypothetical example. Maria is 68 years old and has $900,000 in her traditional IRA. She receives $2,400 per month from Social Security and has no pension. She is in good health and her mother lived to age 96. Maria is worried that if she lives into her nineties, her IRA savings may run out.

Maria decides to invest $150,000 from her IRA into a QLAC with payments starting at age 82. Based on current rates, the QLAC will pay her approximately $1,800 per month for life starting at age 82. She also selects a return-of-premium death benefit so that if she passes away before collecting $150,000 in payments, her daughter will receive the difference.

The immediate benefit for Maria is lower RMDs. When she turns 73, her RMDs will be calculated on $750,000 instead of $900,000 (assuming she has not withdrawn more). This saves her roughly $600 to $800 in taxes per year. When she turns 82, she gains a guaranteed income stream of $1,800 per month on top of her Social Security, giving her financial security well into her nineties and beyond.

Talk to a Licensed Agent About QLACs

Deciding whether a QLAC belongs in your retirement plan is a personal decision that depends on your health, income needs, tax situation, and how long you expect to live. A licensed insurance agent can help you compare QLAC quotes from multiple insurers, estimate your future payments, and evaluate how a QLAC fits alongside your Social Security, pensions, and other savings.

If you are interested in learning more about QLACs or other annuity products that can provide guaranteed retirement income, speak with one of our licensed agents today. There is no cost or obligation, and we can help you understand whether a QLAC is the right tool to protect you against the risk of outliving your money.