+1 (808) 526-1990 info@nexis.tax

Lifetime required minimum distribution (RMD) rules apply to pension plans such as corporate and self-employed pensions, profit sharing and stock bonus plans, traditional IRAs, SEPs and most tax-sheltered annuities. While the rules are complex, you must generally (there are some exceptions) start making an RMD the year in which you turn age 70 ½. To calculate the amount of the RMD you divide the account balance from December 31 of the preceding year by a life expectancy.

But what if you don’t want to draw down on your tax-deferred investments quite so soon? What if you’d like to continue to benefit from as much tax-deferred growth as possible? Until recently, your best options have been delaying your first RMD until April 1 of the year following your 70th birthday or converting to a Roth IRA, which is a taxable event.

In July 2014, though, the IRS completed final regulations (source: IRS bulletin 2014-30) that allow the purchase of a specific type of annuity – called a qualified longevity annuity contract, or “QLAC” – which can be excluded from the RMD calculation when owned inside an IRA, 401(k), 403(b), 457, or other employer sponsored, tax-deferred savings vehicle.

The value of the QLAC is excluded from the RMD calculation up until the year of annuitization, which can be as late as age 85. In general, the QLAC amount excluded from the annual RMD calculation can be up to the lesser of $125,000 or 25% of your retirement account balance (other account assets would remain subject to normal RMD rules).

A longevity annuity differs from an immediate annuity insofar as the income stream starts at a future date rather than at the time of the initial premium payment. A person, for example, could purchase a QLAC at age 65 that doesn’t annuitize until age 85. There are a few important requirements, though, for a longevity annuity to be recognized as “qualified” (i.e., as a QLAC) by the IRS. These are the rules that were finalized last year. Specifically:

  • The amount of retirement savings you can invest in a QLAC is limited to 25% of your IRA account balances combined together and 25% of each separate non-IRA account
  • The 25% maximum is capped at $125,00 across all IRAs and non-IRAs summed together (Roth IRA balances do not count against this cap; Roth accounts don’t have RMDs, after all)
  • The QLAC must provide distributions that start no later than the first day of the month following annuitization, which can be no later than age 85.
  • The QLAC cannot include a variable, indexed, or similar type of annuity contract, nor can it make available any commutation benefit or cash surrender value

Annuities typically have costs associated with them as they are insurance products. Before you purchase a QLAC, make sure you understand all of the potential fees so they can be weighed against the potential tax benefits. The insurance representative selling the QLAC should explain any costs associated with the annuity, and we are always available to discuss the tax implications of your situation.

Also, as these rules are new, this product is not yet widely available. That said, we expect to see insurance companies create more annuities that qualify.

We note that while purchasing a QLAC may help reduce the tax liability tied to taking RMDs (which are taxed as ordinary income) you should also consider whether a QLAC is an appropriate risk management tool for your circumstances.

Please give us a call to discuss this topic further: (808) 526-1990.