If you thought figuring out your RMD—required minimum distribution—was confusing to start with, then consider the challenge faced by individuals whose traditional IRAs include an annuity. According to Kiplinger in a recent article, “RMD Tips: When Your IRA Holds an Annuity,” trying to do these calculations on your own may create more than confusion. Mistakes could be costly.
Here are some tips on what you need to know, if you have an annuity in your traditional IRA.
Remember that your required minimum distributions (RMDs) from an IRA must be taken every year beginning in the year when you hit 70½. You can calculate your RMD by dividing the IRA balance as of December 31 of the previous year by a factor based on your age. However, if your IRA holds an annuity, you may have to add its value when figuring your RMD. The type of annuity is important. There are generally three types: immediate, longevity and deferred variable annuities.
The first two types work pretty simply with RMDs. An immediate annuity results in an instant payment stream. It’s typically paid out over the buyer’s life expectancy. This lifetime stream of payments will cover the RMD for the portion of the IRA money invested in it, so that will duplicate the RMD distribution.
Longevity annuities are bought with money now for payouts starting years later (usually age 85). Qualified longevity annuity contracts (“QLACs”) can be purchased with IRA money (up to 25% of retirement account assets or $125,000—whichever is less). Money that is tied up in an IRA QLAC is not counted, when calculating the IRA’s RMD. It’s based solely on any non-annuity holdings.
However, owning a deferred variable annuity in an IRA, is where RMDs get a bit hairy. The way you determine the annuity’s value in terms of the RMD, depends on whether it’s been “annuitized.” That means it’s been converted into a stream of payments, usually over the owner’s life expectancy. The rules are different when you annuitize a contract. If the variable annuity is simply an asset in your IRA, its value must be included with the non-annuity holdings when figuring the RMD. Even if you’re withdrawing cash from the annuity, its value on the previous December 31 counts for the RMD. Your insurer may give you an RMD estimate based on the annuity’s value, but that will only cover the annuity. The RMD for any non-annuity IRA holdings must also be calculated, and you can take the total RMD from non-annuity holdings.
Again, when the variable annuity is “annuitized,” the stream of payments will cover the RMD for the IRA value represented by the annuity. Most variable annuities are RMD-friendly, experts say. You’re satisfying the RMD with those payments, and you still have an RMD for the non-annuity holdings.
Be extra cautious when calculating the RMD, if you have annuitized the contract after you are subject to the RMD for the first year of payouts. For that first year, your RMD is based on the prior year’s account balance. But—there is a but, you’ll have to make sure that the total payments received during the first year of the annuitized contract are equal to or greater than the calculated RMD. Here’s another spot where it gets tricky. You’ll have to make up the shortfall from non-annuity holdings in your IRA, if they are less. In addition, money that’s tied up in the annuitized contract will be excluded from the IRA’s RMD calculation in later years.
Don’t feel like you have to go it alone when dealing with these kinds of complex financial instruments. To best protect yourself, meet with an estate planning attorney who can help figure this out, and make sure that your RMDs work as part of your overall retirement and estate plan.
Reference: Kiplinger (March 2017) “RMD Tips: When Your IRA Holds an Annuity”