QLAC 101

August 15, 2024

If you’ve saved well for retirement, then you may find you can cover your living expenses without needing to withdraw from your retirement accounts. But if you think that by age 73, you won’t need your full required minimum distributions or RMDs, then you might want to consider getting a qualified longevity annuity contract, or QLAC. 

Anyone between the age of 18 and 75 can purchase a QLAC, but there may be some people that this annuity makes more sense for. If you’re looking to avoid the market risk on some retirement accounts and ensure a steady, guaranteed income in retirement, a QLAC is probably a good fit for you. If you also have concerns about the longevity of your savings and having enough money later in life, then you may benefit from a QLAC. 

Here’s everything you need to know about a QLAC before deciding if it’s right for you.

How a QVAC Could Lower Your RMDs

A QLAC is a deferred fixed annuity contract sold by insurance and financial companies that you purchase with money from a retirement account, like a 401(k) or an individual retirement account (IRA).It’s important to know that Roth IRAs cannot be used to purchase QLACs as they do not come with RMDs to begin with.

RMDs are mandated starting at the age of 73 as of this year, but that will rise to age 75 in 2033. One appeal of the QLAC is that it can reduce the balance in your retirement accounts used to calculate those RMDs. “People tend to spend their RMDs,” says Steven Kaye, a financial planner in Warren, New Jersey. “So a QLAC forces people—in a good way—to leave more money in their IRAs,” he says.

One way to avoid using your RMDs is to use the funds from one of your retirement accounts to purchase a QLAC, which will guarantee that you receive regular payments for as long as you live. “So, if you used 25% of a $400,000 qualified account, your $100,000 purchase of a QLAC would immediately reduce your RMDs by 25%,” says Jerry Golden, investment advisor.  “And the income from a QLAC could be deferred until as late as age 85,” he says.

When you choose a QLAC, you’ll be able to set your payout date, which is when you’ll begin receiving payments. Just like with Social Security, the longer you wait to receive payments, the higher the payments will be. Once you have a QLAC, you’ll be able to delay RMDs until the payout date of your QLAC, which can be no later than age 85.

The Tax Benefits of Having a QLAC

Once you withdraw money from your QLAC, you’ll need to pay income taxes on it. However, a QLAC can be an efficient tax planning strategy. For example, by using $100,000 of a traditional IRA to purchase a QLAC, you’ll reduce the balance of your IRA by $100,000, which will lower the amount you’ll need to take out for RMDs. The lower your RMD, the lower your income will be on that, which could significantly reduce the income tax you’ll owe.

QLAC Contribution Limits and Inflation Riders

You are now permitted to buy a QLAC for up to $200,000 from an eligible retirement plan. Previously, you were limited to whichever was lesser of $145,000 or 25% of your account balance. The current $200,000 upper limit is a combined cap that applies to all of your eligible retirement accounts, even if you take money from different accounts or purchase more than one QLAC. But if you and your spouse have your own eligible retirement accounts, then you can each spend up to the $200,000 limit on your own QLACs.

Since a QLAC locks in future payments, you are protecting your retirement money from market dips later in life. But unless you purchase an inflation rider with your QLAC, which will lower the initial amounts you receive from an annuity, your monthly payment may lose value over time.If you’re considering acquiring a QLAC, then you’ll want to work with a financial advisor to make sure you’re picking the right one.

Considering Your Spouse When Purchasing a QLAC

Some QLACs offer a survivor payout, also referred to as contingent annuity payments. These would continue your annuity payments to your designated beneficiary, which is usually a spouse, after your death. Other QLACs offer death benefits that would return any unused premiums to your beneficiaries through a lump sum or series of payments. If you have a spouse or individuals who will depend on your annuity after your passing, then you need to make sure any QLAC you choose has one of these features. Without these features in your annuity, your survivors would get nothing.

In addition to making sure your QLAC comes with a survivor payout or death benefit, you may also consider getting a joint QLAC with your spouse. If you’re married, a joint QLAC would provide income payments that continue for as long as one of you is alive. The only downside to choosing a joint contract is that it decreases your income payments, compared to a single life contract.

When a QLAC Isn’t For You

If you’re 65 and in poor health, you probably don’t want to wait until age 85 to start receiving income payments, so a QLAC may not benefit you at all. “If the probabilities are that you have a longer than average life expectancy, QLACs can be a windfall,” says Artie Green, a financial planner. “But if you have a shorter than expected longevity, of course, that works against you with any annuitization.” QLAC recipients can use their funds on whatever they want, but often they spend it on late-in-life health care or housing costs. The purpose of a QLAC is longevity protection that could minimize or even eliminate the risks of running out of money.

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There are really only two scenarios in which a QLAC is a good fit. The first is if you have reached age 73 and do not need your RMDs to cover expenses. The second is if you think you’ll reach 73 and not have enough funds to pull from. QLACs can be a safeguard that guarantees you an income late in life, while also reducing your need for RMDs and even lowering your income taxes on them. At Insureyouknow.org, you may keep all of your financial and retirement planning in one place, making it easy for you to forecast and plan for your future.

Saving with a 529 College Plan

August 30, 2021

As college students return to campuses this fall, they (and in many cases, their parents) face costs that have tripled in 20 years, with an annual growth rate of 6.8 percent.

Melanie Hanson at educationdata.org reports that the average cost of college (considered to be any postsecondary educational institution that offers an undergraduate degree program) in the United States is $35,720 per student per year. Current college cost data also reveal:

• The average in-state student attending a public 4-year institution spends $25,615 for one academic year.
• The average cost of in-state tuition alone is $9,580; out-of-state tuition averages $27,437.
• The average traditional private university student spends a total of $53,949 per academic year, $37,200 of it on tuition and fees.
• Considering student loan interest and loss of income, the ultimate cost of a bachelor’s degree may exceed $400,000.

In the academic world, the cost of college is generally referred to as the cost of attendance (COA). Each college has its own COA consisting of five items:

• Tuition and fees
• Books and supplies
• Room and board
• Transportation
• Personal expenses

Twice per year, the federal government recalculates the COA for each college and then adjusts the figures for inflation to determine students’ financial needs when they apply for financial aid.

Planning in Advance

Advance planning for education costs is advisable to keep ahead of college inflation.

Regular investments add up over time. By investing even a small amount of money on a regular basis in a college fund, you have the potential to accumulate a significant amount if you start when your child (or grandchild) is young.

Once you have a sense of your college savings needs, make sure you are investing the money appropriately. Among several available college savings options described by Fidelity, a great place to start is to open and contribute to a 529 college savings plan account. It’s popular with parents and grandparents because there are few restrictions and the benefits are plentiful. You can potentially reduce your taxes and retain control over how and when you spend the money.

Education savings plans were first created in 1986, when the Michigan Education Trust established a prepaid tuition plan. More than a decade later, Section 529 was added to the Internal Revenue Code, authorizing tax-free status for qualified 529 tuition programs. Today there are more than 100 different 529 plans available to suit a variety of education savings needs.

To make sure you are on track with your savings goals, and to ensure you have an appropriate investment mix, revisit your plan at least annually. Over time, you will likely need to update the costs of schools you are considering, your financial aid situation, your child’s school preferences, school location, and your investment performance. When you’re ready to start paying for school, withdrawals are federal income tax-free when used for qualified education expenses.

Setting Up and Using a 529 Savings Account

• The requirements to open a 529 savings account are simple. You must be a U.S. resident, at least 18-years old, and have a Social Security or tax ID number.
• 529 plan savings can cover a range of educational expenses, in addition to college tuition. You can use up to $10,000 from a 529 account each year per beneficiary on elementary, middle, or high school tuition. At the post-secondary level, money saved in a 529 plan account can be used for a variety of higher-education-related expenses: tuition and fees, room and board, books and supplies, and computers and related equipment.
• Money saved in a 529 plan may have only a small impact on financial aid eligibility.
• You don’t have to be related to the beneficiary on the account to open a 529 account for them. Friends or family members can open a 529 college savings account regardless of their income or relationship to the student—and can even name themselves as the student beneficiary on the account. Anyone can contribute and you can encourage donations to a college savings account as a birthday or holiday gift.

Reaping Tax Benefits

A 529 savings plan works much like a Roth 401(k) or Roth IRA by investing your after-tax contributions in mutual funds, ETFs (exchange-traded funds), and other similar investments. Your investment grows on a tax-deferred basis and can be withdrawn tax-free if the money is used to pay for qualified higher education expenses. Contributions are not deductible from federal income taxes. 

You may also qualify for a state tax benefit, depending on where you live. More than 30 states offer state income tax deductions and state tax credits for 529 plan contributions. 

Choosing a 529 Plan 

Nearly every state has at least one 529 plan available, but you’re not limited to using your home state’s plan. Each 529 plan offers investment portfolios tailored to the account owner’s risk tolerance and time horizon. Your account may go up or down in value based on the performance of the investment option you select. It’s important to consider your investment objectives and compare your options before you invest. 

Withdrawing from a 529 Plan 

You can use your education savings to pay for college costs at any eligible institution, including more than 6,000 U.S. colleges and universities and more than 400 international schools. 

Once you’re ready to start taking withdrawals from a 529 plan, most plans allow you to distribute the payments directly to the account holder, the beneficiary, or the school. Read “How to Pay Your Tuition Bill With a 529 Plan” to learn more. 

Remember, you will need to check with your own plan to learn more about how to take distributions. Depending on your circumstances, you may need to report contributions to or withdrawals from your 529 plan on your annual tax returns.

Dealing with Leftover Funds

If your child doesn’t go to college or gets a scholarship, you won’t lose the college fund you have accumulated. Generally, you will pay income tax and a penalty on the earnings portion of a non-qualified withdrawal, but there are some exceptions. The penalty is waived if:

• The beneficiary receives a tax-free scholarship
• The beneficiary attends a U.S. Military Academy
• The beneficiary dies or becomes disabled

The earnings portion of the withdrawal will be subject to federal income tax, and sometimes state income tax.

If you have leftover money in your 529 plan and you want to avoid paying taxes and a penalty on your earnings, you have a few options, including:

• Change the beneficiary to another qualifying family member
• Hold the funds in the account in case the beneficiary wants to attend school later
• Make yourself the beneficiary and further your own education
• Roll over the funds to a 529 ABLE account, a savings account specifically for people living with disabilities
• Since January 1, 2018, parents also have the option to take up to $10,000 in tax-free 529 withdrawals for K-12 tuition
• Since January 1, 2019, qualified distributions from a 529 plan can repay up to $10,000 in student loans per borrower for both the beneficiary and the beneficiary’s siblings

You can withdraw leftover money in a 529 plan for any reason. However, the earnings portion of a non-qualified withdrawal will be subject to taxes and a penalty, unless you qualify for one of the exceptions listed above. If you are contemplating a non-qualified distribution, be aware of the rules and possible tactics for reducing taxes owed.

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If you’re interested in setting up a 529 college savings plan, do your homework on the benefits, qualified uses for account balances, and the low impact on financial aid. File your findings and, once you start receiving account statements, keep track of your college saving account as it prospers.