The IRS recently issued final regulations that facilitate the use of longevity annuities in 401(k) plans, individual retirement accounts (IRAs) and other individual account plans. Longevity annuities typically begin paying out at older ages, often 80 to 85, and are intended to hedge against the risk of outliving retirement savings. Having an assured stream of retirement income beginning at a fixed (albeit advanced) age also could help retirees avoid living beneath their means in the early years of retirement.
The final rules change the minimum distribution regulations, which had created a barrier to longevity annuities. In particular, the value of a longevity annuity that meets certain conditions — a qualifying longevity annuity contract (QLAC) — would not be included in the participant’s account balance when determining required minimum distributions. In general, to be a QLAC, the following conditions must be met:
- A limit on premiums must be satisfied.
- Benefit payouts must commence by age 85.
- No cash surrender value, commutation benefit or other similar feature may be provided.
- Only certain death benefits may be provided.
- Annuity payments must meet the applicable rules for required minimum distributions.
The final rules are largely consistent with the proposed regulations but respond to public comments by expanding the permitted longevity annuities in several respects, including:
- Maximum permitted investment: Under the final rules, participants may use up to the smaller of 25% of their account balance or $125,000 (up from $100,000 in the proposed regulations) to purchase a QLAC. The limit will be adjusted for cost-of-living increases more frequently than proposed: in $10,000 increments instead of $25,000 increments. The dollar limit applies collectively to all premiums paid for QLACs for an employee for all years under any qualified plan, 403(b) plan, 457(b) plan or IRA.
- “Return of premium” death benefit: Under the final regulations, a QLAC can provide a death benefit equal to the excess, if any, of the premium paid over payments received by the participant and spouse from the QLAC. The only death benefit permitted under the proposed regulations was a life annuity to the spouse or a designated beneficiary.
- Correction mechanism: The final rules permit plan participants who inadvertently exceed the 25% or $125,000 limits on premium payments to correct the excess without disqualifying the QLAC. The participant must return the excess premium to the non-QLAC portion of his or her account by the end of the calendar year following the calendar year of the mistake. The excess can be returned either as cash (no mention is made of interest) or as a non-QLAC annuity contract.
QLACs can be provided from a 401(k) or other qualified defined contribution (DC) plan, a 403(b) annuity or a 457(b) governmental plan. They can also be provided from a traditional IRA but not from a Roth IRA. Longevity annuities may not be provided under a defined benefit (DB) plan, despite comments requesting that they be allowed. The IRS is still considering the issue and has requested comments on the advantages to employees of being able to directly elect a longevity annuity under a DB plan, instead of electing a lump sum distribution from a DB plan, rolling it over to a DC plan or an IRA, and then purchasing a QLAC.
Some comments suggested allowing QLACs to include variable annuities or returns based on equity indices, which the final regulations do not allow. However, the IRS clarified that a QLAC may include cost-of-living adjustments and dividends.
The final regulations apply to contracts purchased on or after July 2, 2014. Under a special rule, existing contracts that are exchanged for a contract that meets the conditions for QLAC status may be treated as a QLAC.