In 2014, the US Treasury introduced a longevity pension agreement called a Qualified Longevity Annuity Contract (QLAC), which qualifies as a type of deferred income pension. QLACs can be acquired through various retirement accounts like 401(k)s, 403(b)s, SEP IRAs, and traditional IRAs.
However, it’s important to note that QLACs aren’t available through the Thrift Savings Plan (TSP). TSP participants can roll some or all of their traditional TSP funds into a “rollover” traditional IRA, where they then have the option to purchase QLACs.
Purpose and Creation of QLACs
One of the main reasons for creating QLACs was to address longevity risk. This risk arises from uncertainties about lifespan, particularly the adequacy of retirement income derived from defined contribution plans such as 401(k)s, 403(b)s, and TSPs. Once participants start withdrawing from their TSP accounts, there’s no assurance their funds will last throughout their retirement years.
For example, TSP participants may choose to withdraw their entire account early in retirement. Once they do that, they lose access to those funds. By transferring their traditional TSP accounts to a traditional IRA, participants can then purchase QLACs, thereby reducing exposure to longevity risk associated with TSP funds.
The final regulations for QLACs emerged with the passage of the Secure Act 2.0 in 2022. Before this legislation, the maximum investment in QLACs was capped at $125,000 or 25% of the retirement account’s value. The Secure Act 2.0 made two significant updates: first, the 25% cap was removed, and by 2025, the maximum investment will increase to $210,000 annually. Second, QLACs now include a Premium Returns option, allowing owners to recoup their original investment.
Another noteworthy aspect of QLACs is their ability to postpone Required Minimum Distributions (RMDs) from certain retirement accounts used to purchase them. This could represent a tax-efficient strategy due to lower RMDs, which can reduce both adjusted gross income and taxable income. Additionally, delaying RMDs can lessen federal and state income taxes, along with so-called “stealth” taxes that may affect Medicare premiums.
How QLAC Works for TSP Participants
To purchase a QLAC, TSP participants need to roll a part of their traditional TSP funds into a traditional IRA, but this can only happen once they retire or reach 59.5 years of age. Starting in 2025, participants can contribute up to $210,000 from their traditional IRA to a QLAC. Additionally, each married couple can invest this amount into their QLAC. This contribution limit will be adjusted annually for inflation.
Unlike immediate fixed pensions, which start paying out right away, QLAC payments begin at a future date of the owner’s choosing—but must commence before the owner turns 85. During the deferral period, the investment is no longer subject to market fluctuations, though participants relinquish control over the investment strategy. Insurance firms take on the associated risks, determining how and when payments are disbursed.
Payments from a QLAC are figured based on selected criteria, including the amount invested, the age at which payments start, and options like spousal payments or beneficiary terms.
Who Can Benefit from QLACs?
QLACs aren’t the perfect fit for every TSP participant. Those who could find significant benefits include:
1. TSP participants who wish for guaranteed income that doesn’t depend solely on TSP savings. This option can provide stable cash flow regardless of how long the QLAC owners live.
2. TSP participants looking to lower their traditional TSP RMDs. After a certain age—currently, 73—retirees must withdraw a minimum amount. Fresh strategies, like transferring part of their TSP funds to purchase a QLAC, can help in managing these withdrawals and associated taxes.
For instance, consider William, a 70-year-old retired federal employee with a traditional TSP balance of $1.2 million. He plans to purchase three QLACs at $100,000 each over the next three years. By doing this, he effectively reduces the taxable RMDs he needs to take when he turns 73.
3. Federal retirees who seek financial security. Some retirees prefer certainty regarding their financial future, especially if they already have pensions from CSR or FERS and Social Security. Moving traditional TSP funds to a QLAC can secure lifetime income in ways that remaining in TSP cannot.
4. Federal employees planning for longevity may also find QLACs beneficial, especially if they anticipate living into their late 80s or longer. Structuring a QLAC can ensure continued income for both spouses.
QLAC Payment Options
QLACs offer several payment options, including single life, joint life, and term-specific arrangements. Payments must start by the year the owner turns 85.
- Single life payments stop when the owner passes away.
- Joint life payments continue until both individuals die.
- Term-specific payments ensure fixed benefits for a predetermined period, even if the owner dies before that term ends.
- A cash refund option provides beneficiaries with any remaining balance in the QLAC, although this could reduce the amount of monthly or annual payments received.
For those federal employees and retirees considering multiple QLACs, a “ladder” strategy might be worth exploring. This involves purchasing one QLAC each year for a few years, similar to dollar-cost averaging in investing. It helps spread out the costs and makes it less vulnerable to market volatility.
There are several reputable insurance companies offering QLACs for federal employees and retirees. Prior to making a purchase, it’s wise for potential buyers to thoroughly research the insurers involved.
Before deciding on a QLAC, federal employees and retirees should contemplate several questions:
- How much of your retirement savings should be allocated to a QLAC?
- When should contributions to a QLAC begin?
- What fees and costs are associated with the QLAC?
- Are there options for inflation-adjusted payments?
- How will buying a QLAC influence your overall estate plan?
