Retirement Plan Options for Tax-Exempt Organizations: QLACs

Q: What are QLACs?

A: A QLAC, or qualifying longevity annuity contract, is a fixed longevity annuity that is purchased from an insurance company through an IRA or an employer sponsored retirement plan. It is held in an employee’s retirement account and has special tax attributes.

The Internal Revenue Code (“IRS”) requires distribution of an employee’s qualified plan benefit to commence by a required date - generally, April 1 following the later of the year in which the employee turns 70 ½ or retires. New regulations adopted by the IRS provide that the value of a QLAC held under a plan is ignored when calculating the participant’s required minimum distribution that must begin by that date, thereby lowering the amount of the participant’s required minimum distribution payments.

Essentially, these regulations allow a defined contribution plan or an IRA participant to defer taxation of distributions to a later date by purchasing a QLAC.

Q: Why might a plan offer QLACs?

A: QLACs serve as a method by which plan participants can obtain protection from the possibility of outliving their retirement savings. For example, the preamble to the IRS regulations estimates that an employee who uses $100,000 of plan assets at age 70 to purchase a longevity annuity could receive payments of $26,000 to $42,000/year beginning at age 85, depending on options and actuarial assumptions.

Q: What plans are permitted to offer QLACs?

A: Tax-qualified defined contribution plans under § 401(a) (like 401(k) plans), § 403(b) plans, IRAs under § 408, and eligible governmental § 457(b) plans may offer QLACs. QLACs are not available under defined benefit plans or Roth IRAs.

Q: How much can a participant invest in a QLAC?

A: The regulations provide that a participant can invest in a QLAC the lesser of $125,000 or 25% of the employee’s retirement account balance. The value of the QLAC held under a plan is included in the employee’s account balance for purposes of applying the 25% limit.

For QLACS under IRAs, the 25% limit is based on the total fair market of all non-Roth IRAs, including SEP and SIMPLE IRAs, as of the end of the year prior to the year the QLAC is purchased.

For QLACS under all other applicable plans, the 25% limit is applied separately to each plan balance. In addition, instead of looking to the prior year-end balance of the plan, the 25% limit is applied to the balance on the account’s last valuation date, adjusted by adding in contributions and subtracting distributions made between the last valuation and the time the QLAC premium is paid.

Q: What happens if I accidentally invest too much in a QLAC?

A: The regulations protect individuals against accidental payment of premiums that exceed the 25% or $125,000 premium limits. An annuity contract will not fail to be a QLAC if the excess premium is returned to the non-QLAC portion of the employee’s account by the end of the year following the year in which the excess premium was paid.

Q: When must a QLAC’s distributions commence?

A: Distributions under the contract must commence before a date not later than the first day of the month after the employee turns 85 years old. A QLAC is permitted to allow employees to elect an earlier annuity starting date than the one specified in the contract.

Q: What death benefits can a QLAC offer?

A: A QLAC may offer a single-sum, return of premium (ROP) death benefit to be paid to a beneficiary. If a QLAC is providing a life annuity to a surviving spouse, it may also provide a similar ROP benefit after the death of both the employee and the spouse.

Other than an ROP, the only other death benefit a QLAC may provide is a life annuity to a beneficiary. If the beneficiary is the employee’s surviving spouse, the life annuity payable to the surviving spouse cannot exceed the amount of annuity payment payable to the employee. If the beneficiary is not the employee’s surviving spouse, the life annuity payable to the designated beneficiary cannot exceed an applicable percentage of the annuity payments payable to the employee. The percentage is determined under one of two alternative tables in the regulations.

Q: Are there any annual disclosure requirements?

A: QLAC issuers must file annual calendar-year reports in a form to be prescribed by the IRS regarding the contract’s status. Information required to be included in the annual report must also be furnished to the contract owner on an annual basis.

Q: Are there any prohibited features?

A: QLACs are not permitted to provide variable annuities, indexed contracts or similar annuities. QLACs may, however, increase distributions to account for the payment of dividends or to provide for certain cost-of-living increases. Additionally, QLACs are not permitted to make available any commutation benefit, cash surrender right, or other similar feature.

For more information about QLACs and pension plans, please contact Michael Crowder or one of us at (865) 546-7311 or emails below:

William E. Mason: wemason@kmfpc.com
Kathy D. Aslinger: kaslinger@kmfpc.com
Ashley N Trotto: atrotto@kmfpc.com
Michael Crowder: mcrowder@kmfpc.com