One of our biggest financial challenges is never running out of money in retirement.
Laura discusses a financial product you should understand called a qualified longevity annuity contract or QLAC. You'll learn what a QLAC is, its pros and cons, and who should consider purchasing one.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
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Hi, friends! I'm Laura Adams, and you're listening to the Money Girl podcast! Since 2008, I've been bringing you personal finance and small business tips every week. My mission is to help you get the knowledge and motivation to prioritize your finances, build wealth, and have more security and less stress. I create every show to ensure you come away with practical advice to make better money decisions.
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One of our biggest financial challenges is never running out of money in retirement. That's because many planning factors are unknown, such as how long we'll live, the future inflation rate, or how the financial markets will behave.
While most people qualify for and can rely on Social Security benefits, they were created to be a safety net for retirees, not their sole source of income. If it's your only retirement income, you likely won't receive enough to be comfortable. According to the Social Security Administration, the average benefit paid in 2023 is $1,827 monthly or $21,924 annually.
That's why I frequently recommend that you max out one or more tax-advantaged retirement accounts, such as a Roth IRA and a workplace 401(k), as soon as possible and for as long as possible.
But what if you're still concerned about having enough money for a long life? This show will cover a product that solves that problem called a qualified longevity annuity contract or QLAC. You'll learn what a QLAC is, its pros and cons, and who should consider purchasing one.
A QLAC is a deferred annuity that pays you a guaranteed income in retirement until you and, in some cases, your spouse dies. First, let's step back and review what an annuity is and the various types, then I'll explain more about QLACs.
An annuity is a contract between you and an insurance company that solves financial problems or risks. It pays you an income stream in various ways, such as lump-sum or ongoing monthly payments. You can buy annuities to pay income for a period, such as ten years or the remainder of your life.
There are several ways to categorize annuities, such as how they grow in value and how you purchase them and receive payouts. But the main types are immediate and deferred, which describe how you receive income from an annuity.
With an immediate annuity, you start receiving payments within a year of buying it. But deferred annuities pay you in the future, such as when you retire or at least more than a year from when you buy it. In the meantime, your money grows tax-deferred until you receive it.
With either an immediate or deferred annuity, you can receive an income stream for a period, such as over 20 years, or the rest of your life, so you never outlive your retirement nest egg.
As I mentioned, annuities are also categorized by how they grow and accumulate value. The main three types are fixed, indexed, and variable annuities.
A fixed annuity gives you the least risk and more predictability because you get a guaranteed payment that never changes. An indexed annuity has a payout tied to a market index, like the S&P 500, so they're riskier than fixed products but come with limits on your potential gains and losses. A variable annuity comes with the most risk because payments fluctuate based on underlying investments, and you can have losses.
Now that you have an overview of annuities let's go back to QLACs. I mentioned that they are deferred annuities. You buy one and receive a monthly income stream for as long as you live, so they're also fixed with lifetime income.
What's unique about QLACs is that you must fund them with qualified pre-tax savings, such as from a traditional 401(k) or IRA, with a maximum premium of $200,000 per person as of 2023. No matter when you buy one, you can't receive income from a QLAC until age 73, and you must start taking income before age 85.
Funds you put in a QLAC are not subject to required minimum distributions (RMDs), allowing you to postpone taxes on a portion of your assets temporarily. For instance, if you have a traditional IRA valued at $600,000 and put $200,000 in a QLAC, only $400,000 of the account gets subject to RMDs, reducing your taxable income.
Funds in a QLAC or any fixed annuity are never exposed to market risk because you receive a guaranteed income according to your contract with the provider. That can give you peace of mind that if the market crashes, it won't affect your annuity income. However, as I mentioned, indexed and variable annuities may have market risk depending on your chosen product and its structure.
Most annuities, including QLACs, allow you to buy a single or joint policy. With a single policy, you receive monthly payments until you die, and there are no death benefits for heirs or a surviving spouse. However, you can structure it with a cash refund so any unused funds go to your named beneficiaries.
If you want to protect a partner or spouse's income, you can purchase a joint policy, which pays you until you die and then continues paying your spouse the same amount for the remainder of their life. Again, you can have a cash refund option for beneficiaries. Having a joint policy gives couples confidence that neither will run out of income.
READ ALSO: 7 Changes to Retirement Accounts in 2023 You Should Know
Since every financial product has pros and cons, it's essential to understand the drawbacks of a QLAC. The main disadvantage is getting less flexibility compared to other annuity options. For instance, other products allow you to start taking an income earlier than age 73 or tap a portion of your balance if needed.
Also, fixed annuities may not pay as much compared to what you could get from investing in financial markets. However, it's critical to remember the purpose of a QLAC is limiting market risk and paying you an income for life.
Choosing a financially strong annuity company with an excellent financial rating is essential. When an insurance company fails, policyholders get some protection from their state's guaranty association. The coverage varies by state but might be about $100,000 per policy. That means if you have a $200,000 QLAC and the provider becomes insolvent, you'd likely receive a maximum of $100,000.
If you're considering buying an annuity, work with a reputable financial advisor to understand the risks and which products are right for you. If your goal is to set aside money for the future, delay RMDs and taxes, and have some guaranteed income for life, a QLAC may be worth exploring.
Be sure to follow Money Girl on Apple Podcasts, Spotify, or wherever you listen to podcasts, so you automatically get each new weekly episode! That's all for now. I'll talk to you next week. Until then, here's to living a richer life.