How to Understand Deferred Annuities & QLACs for Steady Retirement Income
Key Takeaways
- Deferred annuities and QLACs both enable you to convert retirement savings into steady future income, providing options for income planning.
- Understanding phases, tax rules, and potential risks helps you make informed decisions about integrating these tools into your retirement strategy.
Planning for steady, predictable income in retirement is a priority for many. Both deferred annuities and Qualified Longevity Annuity Contracts (QLACs) are options that can help accomplish this goal. Understanding their basics—including how, when, and why they work—can leave you feeling more informed and prepared as you shape your retirement plan.
What Are Deferred Annuities?
Deferred annuity definition
A deferred annuity is a financial arrangement designed to turn a lump sum or a series of contributions made now into a stream of future payments. You make contributions (either as a one-time payment or as ongoing deposits), and your money is set aside until a chosen date, often many years into the future. The goal is to let your funds have time to grow before you eventually start taking income from them.
Accumulation and payout phases
Deferred annuities have two primary periods. First is the accumulation phase, where your money goes untouched, accumulating value over time. This period can last several years or even decades, depending on your personal timeline. The second is the payout phase. That’s when the annuity begins to send you regular income payments—monthly, quarterly, or yearly—based on choices you make about timing and duration.
What Is a QLAC in Retirement?
Meaning of QLAC
A Qualified Longevity Annuity Contract (QLAC) is a special kind of deferred annuity designed for use with certain retirement accounts, such as individual retirement accounts (IRAs) or employer-sponsored plans. The unique feature of a QLAC is that it allows you to delay a portion of your required minimum distributions (RMDs) by shifting that amount into a QLAC. You then select a future date (no later than a defined age set by regulations) to start receiving income.
Role in retirement income planning
The QLAC serves as a tool for those who are concerned about outliving their savings, also referred to as longevity risk. By using part of your retirement account to fund a QLAC, you secure another source of income that kicks in later in retirement, often after age 70. This can help provide financial reassurance for your later years, supplementing Social Security or other income streams.
How Do Deferred Annuities Work?
Funding and growth
Deferred annuities typically begin with a contribution from your savings. This could be a single lump sum or a set of payments over time. Once in the accumulation phase, these funds can grow tax-deferred, meaning you do not pay taxes on the growth as it happens. The money remains invested, following the rules set out in your contract, until you choose (or are required) to receive distributions.
Transitioning to income
The payout—or distribution—phase begins when you elect to convert your annuity balance into an income stream. The timing is up to you, within certain age limits. When you make this election, your funds are then distributed to you as periodic payments. The exact amount and duration of your payments depend on your age, the total value, and the payout structure you choose.
When Might You Consider a QLAC?
Required minimum distributions overview
U.S. retirement accounts typically require that you begin withdrawals at a certain age to ensure the government eventually collects taxes on tax-deferred savings. These withdrawals are known as required minimum distributions (RMDs). A key feature of QLACs is that the funds used to purchase a QLAC are excluded from your RMD calculations until you begin receiving QLAC income payments. This gives you flexibility over your annual taxable income during early retirement years.
Longevity risk management
For individuals who want to make sure they won’t run out of money even if they live longer than average, a QLAC can serve as a “backstop.” By delaying distributions until later in retirement, a QLAC can provide steady, predictable income when other resources may be running low. This feature is particularly appealing if longevity risk—that is, the risk of outliving your savings—is a major concern in your retirement planning.
What Are Common Tax Considerations?
Taxable portions of annuity income
While invested within a deferred annuity or QLAC, your funds generally grow tax-deferred. That means you don’t owe taxes each year as your balance grows. When you start taking income, however, you pay ordinary income tax on the portions of each payment that represent investment gains (as opposed to your original contributions, unless the annuity is funded entirely with pre-tax dollars as in most retirement accounts).
Reporting annuity income
When you receive income from a deferred annuity or a QLAC, those payments usually need to be reported as part of your taxable income. The details depend on how your annuity was funded—either with pre-tax dollars (as in a traditional IRA or 401(k)) or with after-tax dollars. In most cases, providers issue annual tax documents to help you correctly report your annuity income.
Are Deferred Annuities Right for You?
Evaluating retirement income needs
Before considering a deferred annuity or QLAC, it helps to take stock of your anticipated retirement expenses and income sources. Assess whether your expected Social Security income, personal savings, or any pensions are likely to meet your core needs. Deferred annuities, including QLACs, may be worth considering if you’re looking for ways to manage future income needs and create stable payouts later in life.
Potential risks and limitations
Like any financial tool, deferred annuities and QLACs come with certain trade-offs. Your money may be tied up and less accessible in exchange for future income. You might not be able to change your arrangement if your financial situation changes significantly. Payout amounts aren’t meant to provide guaranteed results and can depend on choices made at the beginning. It’s valuable to compare risks—such as inflation, opportunity cost, and future needs—against the stability a deferred income plan can provide.
