REG–115809–11, Released February 3, 2012
On February 3, 2012 IRS released proposed regulations regarding the establishment of “qualified longevity annuity contracts” (QLACs). The new QLAC rules will allow retirement account owners to purchase certain annuity contracts with a portion of their retirement assets that will be able to be excluded from their required minimum distribution (RMD) calculations. Annuity payments, the ONLY distribution option available from QLACs (no lump-sum distribution options allowed) will be required to begin by the owner’s 85th birthday. A host of other provisions, including restrictions on the type of annuity that can be offered, the amount of money that can be invested and permissible death benefit options will also apply. The primary purpose behind the creation of QLACs is to help taxpayers in hedging their longevity risk by making it easier for them to purchase certain annuities with their retirement accounts.
Warning – QLACs Do Not Exist Yet
It’s important to remember that the proposed regulations issued by IRS regarding the creation of QLACs are just that…proposed. They are not final regulations and furthermore, they are not even temporary regulations. As such, QLACs do not currently exist and the rules and guidelines discussed in this article are subject to change in the final version of the regulations.
Longevity Annuities and RMDs…What’s the Problem?
Perhaps the biggest obstacle to owning so called longevity annuities (annuities that begin making payments at an advanced age, such as 80 or 85) within IRAs and other retirement accounts has been the required minimum distribution rules. The rules currently require that unless an annuity held within an IRA (or other retirement account) has already been annuitized, its fair market value must be included in the prior year’s December 31st value when calculating RMDs. This has the potential to create planning problems because although the annuity may have a value, it may not be as readily accessible (liquid) as, say, IRA assets held in a brokerage account. As a result, if a client chooses to take what would be the annuity RMD from other IRA assets (in order to leave the annuity alone), it could lead to liquidity issues down the road. On the other hand, the earlier a client is forced to start taking distributions from an annuity because they need the extra money or have to satisfy RMDs, the less annual income the annuity will generally produce.
New Proposed Regulations Can Help Solve IRA Annuity RMD Issues
Under the QLAC proposed regulations, RMD issues will no longer be a concern for certain annuity contracts. Clients purchasing longevity annuities that meet the requirements of a QLAC after the final regulations are issued will be able to completely exclude the value of the annuity from their RMD calculations. If the final regulations are issued soon enough, that could impact a client’s RMD calculations as early as next year (2013). The new QLAC exclusion rules will prevent clients from ever having to tap their qualifying annuities as a way to satisfy RMD payments, and thus, the annuity start date can be “pushed out” to a more advanced age.
Age 85 – The Latest Annuity Start Date
Under the proposed regulations, annuity distributions from QLACs may be deferred, but only until the first day of the month following the person’s 85th birthday. The age-85 requirement is a maximum age for beginning to receive payments, but the regulations do not contain any restrictions preventing QLACs from offering owners the option of starting distributions at an earlier age. However, as the preamble to the proposed regulations explains, offering contract owners the ability to receive distributions at an earlier age would likely increase the cost of those contracts.
Limits on QLAC Purchases
The new proposed regulations do not allow clients to invest an unlimited portion of their retirement savings in QLACs. In fact, the amount of retirement assets an individual can invest in QLACs will be limited by both a dollar amount and a percentage. The total amount of retirement assets that a person can invest in a QLAC will be limited to the lesser of $100,000 or 25% of retirement account assets.
The $100,000 dollar-limitation is a cumulative limit for all QLACs purchased in all retirement accounts. In other words, no matter how many IRAs, 401(k)s and other retirement accounts a client has, they cannot have more than $100,000 invested in QLACs.
The $100,000 limit will be indexed by inflation, but only in increments of $25,000. Therefore, this too is unlikely to change for the foreseeable future.
The amount of retirement assets clients can invest in QLACs is also reduced to a maximum of 25% of their applicable retirement account assets. Unlike the dollar limitation, which as described above is applied cumulatively to all a client’s retirement accounts, the 25% percentage-limitation will generally apply separately to each of a client’s accounts.
There are, however, two key differences between how the 25% limit will apply to plans and to IRAs. First, for plans, the 25% limit applies separately to each of a person’s plans.
For IRAs, the 25% limit will be applied to the total value of all of a client’s IRAs (not including Roth IRAs). The second major difference is that for plans, the balance used to determine the 25% limit is the actual balance on the date the client makes a QLAC purchase. For IRAs, on the other hand, the balance used to determine the 25% limit will be the prior year-end balance.
Disadvantages of QLACs
The ability to exclude the value of a QLAC from RMD calculations will obviously be a huge benefit for some clients, but they will not come without their share of drawbacks. One disadvantage for some retirement account owners is that QLACs will be restricted from being variable annuity or equity-indexed annuity contracts. In the Service’s opinion, since these investments rely, at least in part, on market returns, they would not be consistent with the safety and predictability of retirement income they intend to encourage through the new QLAC regulations.
Another key drawback of QLACs will be their somewhat irrevocable nature. In order to meet the requirements of a QLAC, a contract will not be able to offer “any commutation benefit, cash surrender value, or other similar feature.” In other words, as the kids might say, “No Backsies!” Once a client has purchased a QLAC, it’s theirs for life and the only way they may be able to access funds sooner than the contractual annuity start date is if, and only if¸ the contract allows the owner to voluntarily choose an earlier annuity start date. Even in such cases, the benefit received could not be a lump-sum, but simply the beginning of annuity payments for life.
Death Benefit Options for QLACs
Another big disadvantage of QLACs for some clients will be the lack of death benefit options. In order for an annuity contract to be considered a qualified longevity annuity contract, the only permissible death benefit option will be a life annuity, the same option available to the client during his lifetime, payable to the beneficiary. No additional options, such as a return of premium benefit, a lump-sum benefit or a period certain annuity payout may be offered. The life annuity requirement applies to all QLACs, whether the beneficiary of such a policy is a spouse or a non-spouse designated beneficiary.
Although some rules, such as the restriction to only life annuities, will apply to QLAC death benefits regardless of who the beneficiary is, there are a number of differences between the rules for a spouse who is the sole beneficiary of a contract and other designated beneficiaries of a QLAC, such as the amount of the life annuity as well as the time that the annuity must begin payments.
Remember, QLACs do not currently exist. However, the overwhelming likelihood is that IRS will release final regulations before the end of 2012, adding another valuable planning tool to the retirement planner’s arsenal.