RMD Tips: When Your IRA Holds an Annuity

If your IRA holds an annuity, you may or may not have to include its value when figuring your required minimum distribution.

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Annuities have a reputation for being complex products, and dealing with IRA required minimum distributions isn’t always a walk in the park, either. Mix the two together, and that can result in a concoction of confusion. Here’s what you need to know if you hold an annuity in your traditional IRA.

Required minimum distributions from an IRA must be taken annually starting the year you reach age 70½. Typically, you figure your RMD by dividing the IRA balance as of December 31 of the previous year by a factor based on your age (see IRS Publication 590-B).

But if your IRA holds an annuity, you may or may not have to include its value when figuring your RMD. The kind of annuity you hold matters. Annuities come in many flavors, but generally there are three types: immediate, longevity and deferred variable annuities.

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The first two types have a relatively easy relationship with RMDs. An immediate annuity results in an instant stream of payments, usually paid out over the buyer’s life expectancy. A lifetime stream of payments essentially covers the RMD for the portion of the IRA money invested in it. “That sufficiently duplicates the RMD distribution,” says Mark Luscombe, principal analyst in the tax and accounting business of Wolters Kluwer, in Riverwoods, Ill.

Say you have $300,000 in an IRA and use $100,000 to buy an immediate annuity. The $100,000 is turned into a stream of payments and is excluded from the RMD calculation. You still would have to figure the RMD for the remaining $200,000. But what if the annuity payments are more than the required distribution on the value of the annuity using the IRS method? Sorry, but any excess can’t count as part of the RMD on the nonannuity part of your IRA.

Longevity annuities are bought with a chunk of money now for payouts starting years later, typically at age 85. Qualified longevity annuity contracts, or QLACs, can be bought with IRA money (up to 25% of retirement account assets or $125,000, whichever is less). Money tied up in an IRA QLAC is ignored when figuring the IRA’s RMD. Your RMD is based on any non-annuity holdings.

Owning a deferred variable annuity in an IRA is where RMDs get tricky. How you figure the annuity’s value into the RMD depends on whether or not it has been “annuitized”—that is, turned into a stream of payments, usually over the owner’s life expectancy. “The rules change when you annuitize a contract,” says Ken Nuss, chief executive officer of AnnuityAdvantage.

If the variable annuity is simply an asset in your IRA, then its value must be included along with nonannuity holdings when figuring the RMD. Even if you are withdrawing some cash from the annuity, its value on the previous December 31 counts for RMD purposes, says Bob Gavlak, a certified financial planner at Strategic Wealth Partners, in Columbus, Ohio.

Your insurer may provide an RMD estimate based on the annuity’s value, but keep in mind that it will only cover the annuity, says Joe Heider, founder of Cirrus Wealth Management, in Cleveland. The RMD for any nonannuity IRA holdings must be calculated, too. You can take the total RMD from nonannuity holdings.

When the Rules Twist

But the rules change once the variable annuity is “annuitized,” because the stream of payments will cover the RMD for the IRA value represented by the annuity. “Most [VAs] are RMD friendly,” says Gavlak. “You are satisfying the RMD with those payments.” You still have an RMD for the nonannuity holdings.

If you annuitize the contract after you are subject to RMDs, take particular care with calculating the RMD for the first year of payouts, says Nuss. Your RMD in that first year is based on your prior year account balance, but Nuss says you’ll need to make sure that the total payments you receive during the first year of the annuitized contract are equal to or greater than the calculated RMD. If they are less, he says, you would need to make up the shortfall from nonannuity holdings in your IRA. In subsequent years, the money that’s tied up in the annuitized contract would be excluded from the IRA’s RMD calculation.

Rachel L. Sheedy
Editor, Kiplinger's Retirement Report