When you save for retirement in a traditional IRA or 401(k), your investments can grow tax-deferred in the account for years. But you’ll finally have to pay taxes when you withdraw the money. You have to start taking withdrawals after you turn age 70 ½ — even if you don’t really need the money yet.
These required minimum distributions (RMDs) are based on a life-expectancy factor from the IRS and your account balance at the end of the previous year. For example, if your traditional IRAs are worth $500,000 and you’re 70 ½ at the end of the year, you’ll have to withdraw $18,248 from the account for the first year, and then take another required withdrawal each year after that. If all of your contributions were tax-deductible or made with pre-tax money, then the entire withdrawal would be taxable.
But a special kind of annuity, called a qualifying longevity annuity contract (QLAC) can help you delay taking RMDs on a portion of the account — delaying the tax bill on that money, too.
A deferred-income annuity is a type of annuity that provides lifetime income starting several years in the future. For example, if a 60-year-old man invests $100,000 in a deferred-income annuity that starts to pay out when he reaches age 80, he could receive about $28,800 per year for the rest of his life (a woman would receive about $24,800 per year because women tend to have longer life expectancies than men). If he purchases the QLAC variation of that same annuity, the income will be the same, but the initial $100,000 investment is removed from the RMD calculation and he doesn’t have to pay taxes on that money until he receives it as lifetime income starting at age 80. Like a regular income annuity, the payouts will continue for the rest of his life, guaranteeing that he won’t outlive his savings.
The downside with deferred income annuities and QLACs, however, is that the payouts will stop when the annuitant dies. If the person in the example above dies before turning age 80, he won’t receive anything. If you’re concerned about this risk, one option is to get a version of the QLAC that provides a smaller payout every year, but will pay your beneficiary the amount of money you originally invested, minus any payouts you already received. Adding this cash refund option would lower the annual payouts for the man to about $23,400 (or to about $21,200 per year for the woman).
Married couples can also get a QLAC that pays out for as long as either spouse is alive. If a 60-year-old couple invests $100,000 in a QLAC, they can receive about $23,300 per year starting at age 80 while both spouses are alive, which drops to about $15,600 after the first spouse dies.
You can invest up to $130,000 in a QLAC or up to 25% of the balance in your traditional IRAs and 401(k)s, whichever is less. When you invest the money, you choose the age you want to have payouts start. The younger you are when the payouts begin, the lower the annual payouts will be. You can’t defer QLAC payouts beyond age 85.
One final note. Even though a QLAC can help you delay taking RMDs on some of your retirement savings, that shouldn’t be the main reason for purchasing one. It’s important to make sure that a deferred-income annuity fits within your overall retirement income strategy first. For example, can you afford to give up the liquidity and access to the lump sum in return for lifetime income? Do you have enough money to cover your expenses — and even unexpected bills — before the annuity’s start date? Consider all of these factors before deciding whether a QLAC or any kind of deferred-income annuity is right for you.
Schedule a free call with a friendly annuity expert at Saturday. We can answer your retirement questions and help you decide if income annuities are a fit for you.
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