Extra Caution if There’s an Annuity in Your Traditional IRA

If your IRA holds an annuity, you might have to include its value when figuring your required minimum distribution. Annuities are complex products. Working with IRA RMDs (Required Minimum Distributions) isn’t always easy. Combine the two, notes an article in Kiplinger“RMD Tips: When Your IRA Holds an Annuity,”  and the result can be real confusion. Here are tips on what you must 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 tied up in an IRA QLAC is not counted, when calculating the IRA’s RMD. It’s based solely on any non-annuity holdings.

But owning a deferred variable annuity in an IRA is where RMDs get hairy. The way you determine the annuity’s value in 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.

If you annuitize the contract after you’re subject to RMDs, watch your calculation on the RMD for the first year of payouts. Your RMD in that first year is based on your prior year’s account balance. However, be certain 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’re less, you must make up the shortfall from non-annuity holdings in your IRA. In later years, the money that’s tied up in the annuitized contract would be excluded from the IRA’s RMD calculation.

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