Over the years, more and more employers have dropped their pension plans, which pay a monthly retirement benefit for life, in favor of plans that allow for employee contributions to a tax-deferred retirement account, such as a 401(k) or 403(b) plan.
There are a variety of reasons behind the shift. In general, employees seem to appreciate and value the individual account plans more, even though the costs to the employer are less. They can see the buildup of the retirement nest egg, which may be accelerated if there is an employer matching contribution. The employee gains control over the investment decisions for the account. The account is portable, in that the employee may roll the assets into an IRA when changing jobs. Finally, the employer is “off the hook” for financial market downturns, as investment risks and rewards are shifted to the employee.
However, when the retirement moment arrives, many people prefer the security of the lifetime monthly payments from a pension plan. Recent legislation, the SECURE Act 2.0, provided a path in this direction.
A Qualified Longevity Annuity Contract (QLAC) is a mechanism for turning a portion of an IRA or 401(k) balance into something resembling a pension benefit, while also reducing the size of future Required Minimum Distributions (RMDs) when the account owner reaches age 73. The QLAC may be for the account owner’s life, or the joint lives of the owner and a designated beneficiary. The QLAC starting date for payouts must be no later than the first day of the month following the account owner’s 85th birthday. The RMD rules will not apply to the QLAC, but will continue to apply to any balance remaining in the IRA or 401(k).
Effective this year, the amount that may be moved from an IRA or 401(k) to a QLAC is increased from $145,000 to $200,000. Earlier law also included a cap on the investment: No more than 25% of the account balance could be invested in a QLAC. That meant that only an individual with an account balance of $580,000 or more could get the full benefit of the pension. The cap of 25% of the account balance for a QLAC investment was eliminated by the SECURE Act 2.0.
A variety of additional restrictions apply to QLACs, including that the annuity contract is not variable or indexed, but a cost-of-living adjustment is allowed. A QLAC may also provide for a return of premium feature. One expects that the total payouts from the QLAC will be larger than the premium paid for it. In the event of an early death, to the extent that the total annuity payments are less than the premium paid, the difference may be paid to the estate or to a beneficiary.
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