In 2014, the US Treasury Department introduced Qualified Longevity Annuity Contracts (QLACs) as a type of deferred income annuity. QLACs can be purchased within certain types of retirement accounts including 401(k)s, 403(b)s, SEP IRAs, or traditional IRAs.
While QLACs are not available through the Thrift Savings Plan (TSP), TSP participants have the option of directly rolling over a portion or all of their traditional TSP account to a “rollover” traditional IRA from which a QLAC can be purchased.
Why were QLACs created and what purpose do QLACs serve?
One reason that QLACs were created was in order to minimize longevity risk. Longevity risk is the risk associated with outliving one’s retirement income. Specifically, retirement income in the form of defined contribution plans such as the 401(k)s, 403(b)s and the TSP. Once a TSP participant starts to withdraw from his or her TSP account, there is no guarantee that the withdrawals will last throughout the life of the TSP participant.
A TSP participant could withdraw his or her entire TSP account in the early years of the participant’s retirement. Once that happens, the participant will have no TSP funds to withdraw, thereby “outliving” the TSP account. As will be explained, by transferring some or all of his or her traditional TSP account to a traditional IRA and then to a QLAC, the TSP participant will minimize the possibility of being subject to longevity risk for the portion of the traditional TSP transferred to the QLAC.
Final rules for QLACs came out as part of the passage of SECURE Act 2.0 in 2022. Before SECURE Act 2.0 passage, the maximum amount that could be invested in QLACs was the lesser of $125,000, or 25 percent of the retirement account value. With the passage of SECURE Act 2.0, came two important changes, namely:
(1) The limit of 25 percent has been removed, and a dollar upward limit is used each year with a $210,000 limit in 2025; and
(2) A “return of premium” option on all QLACs which allows a QLAC owner to receive the original purchase amount less any payouts.
One of the more key features of QLACs is that it allows qualified retirement plan participants and traditional IRA owners to defer required minimum distributions (RMDs) from the portion of their retirement savings that they use to buy the QLAC. This can be a tax-efficient strategy as a result of smaller RMDs initially, thereby reducing adjusted gross income and taxable income. Besides reducing annual federal and state income taxes, this can also result in the lowering of “stealth” taxes such as the net investment income tax (NIIT) and Medicare Part B and Medicare Part D monthly premiums.
How can QLACs work for TSP participants?
TSP participants can purchase a QLAC by first directly rolling over a portion of their traditional TSP account to a traditional IRA. To do so, the TSP participant must be retired from federal service or if still a federal employee, be at least age 59.5. During 2025, up to $210,000 of the traditional IRA balance can be contributed to the QLAC. Married couples can each put $210,000 into their QLACs. The maximum annual QLAC contribution amount is indexed for inflation annually.
Unlike immediate fixed annuities, in which income payments start shortly after their purchase, QLAC income payments are deferred to a future date. The QLAC owner gets to choose when the payments start; however, QLAC payments must start before the annuitant’s 85th birthday. During the deferral period, the money invested in the contract is no longer subject to market risk, although control over how to invest is lost. The insurance company is now taking the risk, and the contract at the time of purchase determines how the money will be paid back and when the income stream starts.
The QLAC payments are calculated based on the amount invested, age when payments start, and the options selected, including whether the payments will continue to a surviving spouse, whether there is a beneficiary, or whether there is a “period contain” in which payments are guaranteed for a set period such as 10 or 20 years, even if the annuitant dies before the set period is over.
Which TSP participants can benefit from QLACs?
QLACs are not appropriate for all TSP participants. TSP participants who could benefit most by purchasing QLAC include:
1. Those TSP participants who do not want to outlive their TSP savings and want an alternative to the TSP annuity. The guaranteed income stream ensures there will be a steady cash flow of TSP income, no matter how long the QLAC owner lives.
2. Those TSP participants who are looking to reduce their traditional TSP RMDs. Upon reaching their required beginning date (RBD) (currently, April 1st following the year the retired TSP participant reaches age 73) a retired TSP participant must withdraw a minimum amount of their traditional TSP. The larger the traditional TSP account balance, the larger the traditional TSP RMD and the larger amount of taxable income. By using a portion of their traditional TSP to transfer to a traditional IRA in order to purchase a QLAC, the traditional TSP participant can reduce the balance in his or her traditional TSP account. The result is a smaller traditional TSP account balance subject to RMD and potentially a lower federal and state income tax bill.
The following example illustrates:
William, age 70, is a retired federal employee. His traditional TSP account balance is $1,200,000. William plans to purchase three $100,000 QLACs over the next three years, before January 1 of the year he becomes 73. In so doing, he will remove a total of $300,000 from his traditional TSP account that is currently subject to RMD. For his first year TSP RMD when William will be age 73, he will reduce the amount of his taxable TSP RMD by:
$300,000 (amount of traditional TSP not subject to RMD)/26.5 (life expectancy factor) = $11,321.
William’s TSP RMD savings will continue each year until he starts withdrawals from his QLAC. This could be until the year William becomes 85.
3. Federal retirees who value financial certainty. Some retirees like to know exactly what their financial future will look like. They will have a guaranteed pension in the form of a CSRS or FERS annuity and Social Security. Transferring their traditional TSP account to a QLAC will result in guaranteed lifetime income which would not be the case if the money remained in the TSP.
4. Married federal employees planning for longevity. A QLAC can be structured to provide income for both spouses. If a federal retiree is planning for the possibility that the retiree and his or her spouse will live into their late 80’s,90’s or beyond. The purchase of a QLAC using a traditional TSP account can be a smart way to ensure income lasts throughout both lifetimes.
Options for QLAC payments
There are several options for QLAC payments including single life, joint life, or period certain. Note that QLAC payouts must begin no later than the year the QLAC owner becomes age 85. Some things to note about QLAC payments:
• Payments are highest with a single-life annuity since the payments stop with the death of the QLAC owner.
• Joint-life QLACs payments will continue until the death of the second annuitant.
• Period certain annuities guarantee a payment for a set period. For example, 10 or 20 years, even if the QLAC owner dies before that period is over,
• If a QLAC owner wants to hedge against dying prematurely, then a cash refund option would ensure that a designated beneficiary will receive the balance left in the QLAC. The balance left is the original amount invested less the total of all income payments prior to death. However, choosing the cash refund option will lower the monthly/yearly payment amounts.
Federal employees and retirees interested in purchasing multiple QLACs may want to consider “laddering” multiple QLAC contracts. “Laddering” QLAC contracts means purchasing one QLAC per year for several years. This strategy is similar to “dollar-cost” averaging which is an approach to purchasing an investment in which the investor spreads out purchases in order that the total price paid is less affected by market timing.
Federal employees and retirees interested in purchasing QLACs have several high-rated insurance companies to choose from. Before choosing to buy a QLAC, federal employees and retirees are advised to perform due diligence on the insurance company selling the QLAC, including the company’s financial strength and the offered payouts.
Here are some questions that federal employees and retirees should consider before purchasing QLACs:
1. How much of their retirement savings, including traditional TSP and traditional IRAs, should be allocated to a QLAC?
2. When should QLAC payments start? They must start no later than the QLAC owner’s 85th birthday.
3. What are the fees and costs associated with the QLAC they are considering?
4. Are there inflation-adjusted payout options?
5. How will the purchase of a QLAC affect the federal employee’s or retiree’s overall estate plan?
