I Made My QCD CGA, Can I Have a QLAC Now?

Some early adopters of the qualified charitable distribution (QCD) charitable gift annuity have begun to turn their attention to another opportunity to reduce their required minimum distribution: the qualified longevity annuity contract (QLAC). If, like several clients we have heard from, your organization is receiving calls from donors asking if they “can do a QLAC” with your organization, here’s a primer on this vehicle, how it can be used to reduce required minimum distributions from an IRA, why a donor might confuse it with a deferred gift annuity, and some advice on how to redirect a donor’s interest towards a flexible gift annuity. 

The QLAC

The qualified longevity annuity contract is a commercial deferred annuity purchased by a tax-free transfer of a portion of an individual’s qualified retirement plan. An individual with a traditional Individual Retirement Account (IRA), can purchase a QLAC from assets held within their IRA; however, a QLAC cannot be purchased from within a Roth IRA.

Interest in the QLAC stems from its inclusion in the Secure 2.0 Act of 2022. Gift planners may remember this legislation brought into being the qualified charitable distribution charitable gift annuity. But the Secure 2.0 Act also had other provisions designed to enhance when and how retirement plans are used. For instance, it pushed back to 73 the age at which a retirement plan owner must start taking required minimum distributions (RMDs). In addition, it made the purchase of a QLAC more attractive by exempting it from the RMD calculation between the time the contract is purchased and when it begins payment.

Under the Secure 2.0 Act, an individual may move up to $200,000 into a QLAC, provided that the annuity meets the following provisions:

• The premium to purchase the QLAC does not exceed $200,000 (this amount is indexed to inflation beginning in 2024);
• The QLAC must provide guaranteed monthly payments that begin on the annuity start date;
• The start date of the contract cannot be later than the first month following the 85^th birthday of the annuitant; and
• The contract cannot be commuted or surrendered for cash.

How a QLAC Minimizes RMD

The required minimum distribution (RMD) from an IRA is calculated annually, based on the age of the plan owner and the value of the assets within the plan. In principle, the RMD is designed to push the IRA towards near exhaustion over the life expectancy of the owner, thereby discouraging the practice of treating an IRA as an asset to be transferred to heirs.

A qualifying QLAC held within an IRA is exempt from the calculation of the retirement plan’s value, thereby reducing the RMD. For instance, a 73-year-old with an IRA invested in a mix of assets worth $500,000 would find themselves with an RMD of approximately $18,800 in 2024. However, if they had purchased a QLAC with a single premium payment of $100,000 that defers income until age 85, even though the QLAC is held within the IRA and continues to have a defined market value, it would be excluded from the RMD calculation. Rather than calculating the RMD on the full $500,000, the RMD would be calculated on the lower $400,000, producing an RMD of approximately $15,000. The exclusion of the QLAC would continue until the trigger date was reached, at which point the QLAC would become part of the RMD calculation.

That QLAC is Not a DGA

Some donors assume that because they could fund an immediate gift annuity with a QCD, they must be able to use funds from their IRA to purchase a QLAC from their favorite charity. They can’t. This confusion stems partly from the similarities between the QLAC and a deferred gift annuity (DGA) with a monthly payment structure.

In both instances, the donor converts an existing asset into a stream of future monthly payments. With both, the date on which the payments will begin is known and the payout amount is fixed for life. However, this is where the similarities end.

Here are some key differences between the two vehicles.

• QLACs are a form of life insurance, whereas DGAs belong to the bargain sale class of charitable gifts.
• A QLAC has a fixed deferral date, and while that can be earlier than age 85, it cannot be deferred later than age 85. In contrast, a DGA can defer payments well past the age of 85. In fact, a donor aged 85 or older may establish a new DGA.
• The QLAC is purchased with pre-tax dollars, and this results in annuity payments taxed at ordinary income rates. The DGA initially produces a blend of tax-free and ordinary income (for gifts of cash) or a blend of capital gain, ordinary, and tax-free income (for gifts of appreciated assets).
• The tax benefit of the QLAC is that it is purchased with pre-tax dollars. The tax benefit of the DGA is the charitable deduction, and the reduction of capital gains tax if established with an appreciated asset.
• A QLAC cannot be commuted or surrendered for cash. However, a DGA can be “cashed out” by common agreement between the charity and the annuitant.

Why Might My Donor Want a QLAC?

IRA’s provide variable income, as the principal is exposed to market volatility. In addition, they are designed to waste in value over the owner’s life expectancy. Holding a QLAC within the IRA provides a hedge against the total wasting of the IRA’s value. A QLAC is attractive to an individual who worries they might outlive the value of their IRA, since the contract will kick in no later than age 85 (the exact date must be determined at the time the QLAC is established) and then provide fixed income for life.

Individuals can decide to purchase the QLAC long before their RMD needs to be calculated. For instance, a QLAC purchased at age 55 and deferred to age 85 will have lower monthly or single premium payments than one purchased at age 73 and deferred to age 85.

Consider the Flexible Gift Annuity

The QLAC has two points of inflexibility that may trouble your donor: there’s no ability to cash in early and no ability to change the date on which you begin receiving payments. If you’re talking to a donor, and they either ask you about the QLAC or reveal that they are considering one, you can introduce them to the flexible gift annuity (FGA), which offers more flexibility than the QLAC while providing many of the same benefits.

By establishing an FGA, the donor can defer payments until they decide they need it. The longer they defer payments, the higher the payments will be when activated. If they decide they need the annuity earlier than originally anticipated, they can “pull the trigger.” Once a donor activates the payments, the payments are fixed for life.

In addition, should the donor need or want to “cash in” the annuity, they can request that the charity pay them the value of their annuity interest and release the rest of the annuity (inclusive of any growth) to the charity. This amount is the investment in contract as of the date the annuitant signs the severance document, and it can be easily calculated in PGM Anywhere using the Non-charitable Interest Actuarials chart. This form of early termination frees up the charity’s portion of the FGA, allowing it to be used while the annuitant is still alive.

If your donor likes the idea that there’s a forced annuity start date to the QLAC, that is also a feature of the FGA. A donor can specify that an FGA will begin payments, even if the annuitant does not initiate them, at a fixed date in the future. This could be set to age 85, like the QLAC, or to an even later date. Donors who worry that incapacity could cause them to forget about their FGA can take comfort in this.

Lastly, the FGA cannot be funded by a QCD, so a donor interested in funding this vehicle with their IRA would first have to withdraw the gift amount from their IRA before contributing it to the charity. This would be a taxable withdrawal, but the donor would also receive a mitigating charitable deduction for funding the FGA.

Final Thoughts

It is not a fundraiser’s job to define the benefits of a QLAC for their donors, talk them out of what may be an excellent retirement plan strategy for their individual circumstances, or provide financial advice. But it is helpful to be aware of the QLAC, understand why your prospect might confuse it with a deferred gift annuity, and be able to explain how a flexible gift annuity could provide them similar annuity benefits with greater flexibility.