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IRS Issues Guidance on Longevity Annuities

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The IRS recently issued guidance on the use of longevity annuities in defined contribution plans and IRAs.  These longevity annuities are known as “qualified longevity annuity contracts” or “QLACs.”

A QLAC is a deferred annuity that begins at a specified age, but not later than age 85.  This type of annuity allows individuals to have a guaranteed stream of payments beginning after the annuity starting date and continuing for the individual’s life.  A QLAC is intended to help individuals hedge against outliving their retirement benefits.

Plans that may offer QLACs

Employer sponsored defined contribution plans including Section 401(k) plans, Section 403(b) plans, government sponsored Section 457(b) plans and IRAs may provide for the purchase of a QLAC in the plan or IRA.

Limitation on amount of the QLAC

Under the final regulations, the maximum amount of the premiums paid for a QLAC cannot exceed the lesser of (1) 25% of the account balance or (2) $125,000.  The value of the QLAC is included in the participant’s account balance for purposes of determining the 25% limit.  This amount is aggregated across all retirement plans or IRAs for that individual.

Exception to Required Minimum Distribution Rules

Generally, distribution of a participant’s entire account balance must begin by the required beginning date, which is generally April 1 of the calendar year following the later of (1) the calendar year in which the employee attains age 70½ or (2) the calendar year in which the employee retires.  The final regulations provide an exception to these minimum distribution rules by permitting the value of a QLAC to be ignored for purposes of calculating the minimum distribution requirements.

Death Benefits

The final regulations permit a QLAC to include a return of premium feature that guarantees that if the individual dies prior to receiving payments equal to at least the total premiums paid on the annuity contract, then an additional payment may be made to ensure that the total payments received are at least equal to the total premiums paid under the contract.

If the QLAC does not include a return of premium feature, then the only death benefit permitted is a life annuity to a beneficiary.  If the beneficiary is the employee’s surviving spouse, the annuity payment is a life annuity that cannot exceed 100% of the annuity payment to the employee.  If the beneficiary is not the individual’s surviving spouse, the death benefit is a life annuity to the beneficiary in an amount not to exceed an applicable percentage of the annuity payment paid to the employee.  The applicable percentage is determined based on tables provided by the final regulations.

Issues to consider

A defined contribution plan is not required to offer QLACs.  Any decision to include this type of investment option should be considered by plan fiduciaries.  In making a decision to offer a QLAC, plan fiduciaries need to consider the portability of the QLAC as well as the terms of the QLAC, the pricing of the QLAC and the financial strength of the insurance company offering the QLAC.