Advantages of a QLAC

Submitted by Mario Paparozzi on Thu, 2015-07-02 11:58

I have about $700,000 in IRAs. I am 66, my wife is 61. I just read about QLACs, and they seem like a great idea for the purpose of reducing RMDs when I turn 701/2. I still work, and my wife and I collect pensions from former employers. With our pensions and social security (which we are not planning to take until later), and any money that we may earn, we are concerned about getting hit with high taxes, Medicare penalties, etc. I am considering transferring $125K from my IRA and buy a QLAC. If I do that, will I have to pay tax on the $125K now, or later? I would also be interested in knowing some informed opinions about QLACs, in general.

Thank you,

Mario



Submitted by Bruce Steiner on Thu, 2015-07-02 16:31

  • Like any annuity, the QLAC hedges against the risk of living too long and outliving your money, and the risk of living too meagerly for fear of living too long and running out of money.

 

  • However, like any annuity, there’s a significant economic cost.  Since there’s a cost to running the insurance company, the present value of the benefits is less than the cost of the annuity.

 

  • In the case of a QLAC, there’s a tax benefit.  The tax benefit is that the value of the QLAC is disregarded for purposes of calculating the required distributions.  That may offset some or all (or more than all) of the economic cost of the annuity.  I haven’t run any numbers to see whether the tax benefit of the QLAC is more or less than the economic cost of the annuity.

 

  • Another possibility, assuming the IRA owner has sufficient assets that he/she doesn’t need to hedge against the risk of living too long and running out of money, is converting some or all of the IRA to a Roth IRA, either all at once or over a number of years, since there are no required distributions from a Roth IRA during lifetime.

 

  • Bruce Steiner, attorney, NYC, also admitted in NJ and FL

 

Submitted by Alan - IRA critic on Thu, 2015-07-02 16:46

If your QLAC premium was 125k, that amount plus any earnings generated on the 125k as of each year end would not be included in your IRA balance for RMD calculation purposes. Therefore, your taxable income would be lowered until the QLAC was required to make payments. But your RMDs are back loaded and start at age 70.5 at around 3.7% of your prior year end balance. By age 85 when the QLAC payments begin, the RMD will have risen to 6.8% of the IRA balance. You would then have the QLAC payments added to your regular RMD, so your taxable income could spike if you do not have deductions to offset the additional income. Of course, if you have nursing home or other high medical costs in those years, the itemized deductions might offset some or all of the additional income. I also suspect that in 20 years, the Medicare surcharges (IRMAA) will catch many more taxpayers since it is not inflation adjusted and the tiers were just readjusted again this year. While an oversimplification, a QLAC saves taxes till 85, then the higher taxable income kicks in. Of course you will also have more after tax income left if you live long enough.

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