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Sophisticated Investor was fortunate enough to chat with Jordan Sester, Founder and Wealth Advisor at J.S Financial Group. Jordan helps clients prepare for one of the most important periods in their lives: retirement. He works with retirees and pre-retirees to discover their unique needs and goals, then helps them create a strategy to achieve them. in this exclusive interview, Jordan discusses everything an investor should know about a QLAC (Qualified Longevity Annuity Contract).
What exactly is a Qualified Longevity Annuity Contract (QLAC)?
A QLAC is essentially a deferred income annuity. A deferred income annuity is an insurance contract an investor would purchase to ensure they don’t outlive their money. The investor effectively transfers the risk of running out of money to the insurance company, who in turn guarantees to provide an income stream to the investor for as long as they live. The purpose behind a QLAC is not only to provide a lifetime income stream but is to also allow investors to defer RMDs on a portion of their qualified money. To break it down very simply, an investor would give a portion of their qualified money to an insurance company for a certain period of time, and in turn, the investor won’t have to pay taxes on that money until they decide to begin receiving income payments from the insurance company. These are a less known strategy that is approved by the Treasury Department and the IRS to use within qualified plans (401(k), 403(b), IRA (non-Roth) and non-governmental 457(b) plans).
What sort of investor would be a good fit for QLACs?
In general, anyone can invest in a QLAC but they are most appropriate for someone who has a higher net worth and have a large portion of their assets in qualified accounts. The QLAC not only generates an income stream the investor can’t outlive, it also allows for the investor to defer their RMD on up to $130,000 of qualified money. This RMD deferral helps the investor to reduce their immediate taxable income potentially giving them the ability to save money on Medicare premiums, qualify to contribute to a Roth IRA, etc.
Would you recommend them as a component in retirement planning, and why?
There are only three income sources a retiree has that are guaranteed they won’t outlive in retirement. The first one is a pension. We’ve seen the number of pensions offered drastically reduce over the past 10-15 years due to companies being unable to meet funding goals. The second one is Social Security. While the government may have funding issues and will likely have to reduce benefits in the future, there is guaranteed to be an income stream there. The third source of guaranteed lifetime income, is an annuity. An annuity is a contractual obligation from the insurance company to payout to the beneficiary, with an option to pay for as long as the investor were to live. QLAC’s are a type of annuity that fit this description. QLAC’s are a suitable recommendation when an investor is looking to retire with peace of mind and/or when the investor is wanting to defer their taxable income. There is no one size fits all determination and each client situation should be properly evaluated to determine if they meet the needs for a QLAC, but when looking for income the investor can’t outlive or a tax reduction strategies, a QLAC may be the best fit.
In your opinion, what are the most important factors an investor should know about a QLAC?
The most important thing to know is that an investor may only put a maximum of 25% of their qualified accounts, up to $130,000, into a QLAC. They must also keep in mind that the latest they can defer their taxable income is age 85. I strongly recommend they include a cost of living adjustment (COLA) on their QLAC. This will allow for the investor to maintain their purchasing power as their income will increase as the CPI increases.
What are the potential risks or drawbacks investors ought to be aware of surrounding QLACs?
Since these contracts are principal protected, meaning an investor cannot lose money in the market, there is no market risk associated with a QLAC. The main drawback surrounding QLACs is the opportunity cost of such an investment. QLACs are meant to be a safe, long-term, type of investment. Meaning that the internal rate of return on the investment is generally 1-2%. If the investor passes away before using the lifetime income option feature, the beneficiaries will only receive the initial deposit – not the initial deposit + interest. This is why the investment should only be used for those looking for income they can’t outlive or those looking to reduce their taxes due to a sizeable qualified portfolio.
Thank you to Jordan for taking the time out of his busy schedule to chat with us!