How Do RMDs (Required Minimum Distributions) Work With Annuities

As you plan for retirement, you may have come across annuities as a potential investment option. RMDs is an acronym that stands for required minimum distributions. The RMD of an annuity policy is the amount you need to take out annually in the form of income per the government’s requirements. 

How Do Rmds Work With Annuities?

While they offer several benefits, it’s important to understand how annuities work and their associated rules, such as Required Minimum Distributions (RMDs). In this article, we’ll dive deeper into how RMDs work with annuities and what you need to know to make informed decisions about your retirement planning.

Interested in exploring the world of annuities? Read our comprehensive article on How Do Annuities Work? for a detailed overview after you learn about how RMDs effect Annuities!

By the way, make sure to consult a tax specialist if you have specific tax questions!

Required Minimum Distribution (RMD)

Required Minimum Distribution (RMD) is a rule that applies to many retirement accounts, including Traditional IRAs, 401(k)s, and 403(b)s. It requires individuals to withdraw a minimum amount from their retirement accounts each year after they turn 72 years old (70 1/2 if you reached that age before January 1, 2020).

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Retirement Plans That Require Minimum Distributions

The RMD rule applies to most retirement plans, including Traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k)s, 403(b)s, and other qualified retirement plans.

Roth IRAs do not require RMDs as long as the account owner is alive.

Why Some People Don’t Like RMDs?

One of the reasons why some people don’t like RMDs is because they can increase your taxable income, potentially pushing you into a higher tax bracket. 

This can also impact the taxation of Social Security benefits, capital gains, and dividends.

RMDs can increase your Medicare premiums, which are based on your modified adjusted gross income (MAGI).

How To Calculate Required Minimum Distributions?

To calculate your RMD, you need to know the account balance at the end of the previous year and your life expectancy factor. 

You can use the Uniform Lifetime Table, provided by the IRS, to determine your life expectancy factor. Your RMD is calculated by dividing your account balance by your life expectancy factor.

Correcting RMD Mistakes

If you forget to take your RMD or withdraw less than the required amount, you may be subject to a 50% penalty on the amount that should have been withdrawn. 

If you realize the mistake and correct it promptly, you may be able to avoid or reduce the penalty by taking corrective measures and reporting the error to the IRS.

The Pros and Cons of Annuities Infographic (Tax-deferred growth, guaranteed income, diversification, fees, restrictions, inflation risk).

Strategies For Postponing Or Minimizing RMDs

If you don’t need the money from your retirement account, there are some strategies you can use to postpone or minimize your RMDs. 

One strategy is to convert your Traditional IRA to a Roth IRA, which doesn’t require RMDs. Another strategy is to donate your RMD to a qualified charitable organization, which can help reduce your taxable income and satisfy your RMD requirement.

SECURE Act 2.0 – Change Required Minimum Distribution To 75

A new piece of legislation called the SECURE Act 2.0 proposes to increase the age for the first RMD from 72 to 75. This would provide individuals with additional time to save for retirement and postpone their RMDs. The bill has not been passed into law yet, but it is something to keep an eye on if you’re planning for retirement.

Are Annuities Subject To Required Minimum Distribution?

Annuities are generally subject to required minimum distributions (RMDs) once the owner reaches age 72 (or age 70 1/2 for those who turned 70 1/2 before January 1, 2020) and has a non-qualified annuity or an annuity held in a traditional IRA or other tax-advantaged retirement account. 

Definition: An RMD is the minimum amount that the account owner must withdraw each year from their retirement account, and pay taxes on, according to the IRS regulations. 

The purpose of RMDs is to ensure that retirement account owners do not defer their taxes indefinitely and take distributions in their retirement years.

Special Note: immediate annuities are considered “exempt” from RMDs since the payments from these types of annuities are structured to provide income for life, which means they already act like RMDs.

The amount of the RMD can vary based on the account balance, the account owner’s age, and life expectancy. Failing to take RMDs can result in penalties from the IRS, so it’s essential for account owners to understand the RMD rules and requirements for their specific annuity.

RMD Rules For Deferred Annuities

For deferred annuities, which are annuities that have not yet begun paying out, the RMD rules are the same as they are for traditional Individual Retirement Accounts (IRAs). That means that once you reach age 72, you are required to begin taking RMDs from your deferred annuities.

The amount of the RMD is calculated based on the value of the annuity and your life expectancy. If you don’t take the required distribution, you will be subject to a hefty penalty of 50% of the amount you should have withdrawn.

Using Annuities To Defer RMDs

One way to delay RMDs from your retirement accounts is to use an annuity. By purchasing an annuity, you can defer the start date of payments and therefore delay the RMDs. The longer you defer the start date, the longer you can postpone taking RMDs.

Note: all annuities are created equal when it comes to RMDs. For example, variable annuities may have higher fees and lower returns, which can affect the overall value of the annuity and the amount of the RMD.

It’s important to carefully consider the terms of any annuity before purchasing it, especially if you are using it as a way to defer RMDs.

RMD Rules For Immediate Annuities

Immediate annuities are a popular type of annuity that provides a guaranteed stream of income for a fixed period or the rest of the annuitant’s life. 

Unlike some other types of annuities, immediate annuities are exempt from required minimum distributions (RMDs) until a specific time.

Why Are Immediate Annuities Exempt From RMDs?

Immediate annuities are designed to provide a regular stream of income to the annuitant. The RMD rules were developed to ensure that retirement account holders are using their funds during retirement and not just letting the money accumulate tax-free. 

Because immediate annuities provide regular payments, they are considered to be in compliance with the spirit of the RMD rules, and therefore are exempt from RMDs.

RMD Calculation For Immediate Annuity

If you own an immediate annuity, you are not required to take RMDs until a specific time, which is usually after a certain number of years or when you reach a specific age. 

If, for example, you bought a $500,000 immediate annuity that pays $25,000 per year, you would not have to take an RMD until the year after the annuity term ended or after you reach the age of 72, whichever comes later.

What About RMDs In The Year I Buy My Annuity?

In the year in which you purchase an immediate annuity, you do not need to take an RMD on the funds used to purchase the annuity. 

This is because the funds used to purchase the annuity are no longer considered part of your retirement account once they are used to purchase the annuity.

Who Has To Take An Annuity RMD?

Individuals who own a qualified annuity or a non-qualified annuity within a qualified plan, such as a 401(k) or IRA, may have to take Required Minimum Distributions (RMDs) from their annuity.

While annuities offer many benefits, such as tax-deferred growth and a guaranteed income stream, they are subject to certain rules and regulations, including required minimum distributions (RMDs).

When Is An Annuity Considered Annuitized?

An annuity is considered annuitized when the annuity contract owner elects to receive a series of regular payments from the insurance company. The payments can be for a fixed period of time or for the annuitant’s lifetime. Once an annuity is annuitized, the payout amount is typically fixed and cannot be changed.

Do Annuity Payments Count Towards RMDs?

Yes, annuity payments received from a non-qualified annuity (i.e., an annuity not held in a tax-advantaged account) count towards RMDs. 

However, payments received from a qualified annuity, such as a variable annuity held in an IRA, do not count towards RMDs.

When Your IRA Holds An Annuity?

If your IRA holds an annuity, it is important to calculate the RMD correctly to avoid penalties. One option is to take the RMD from the annuity itself, if allowed by the annuity contract. 

Another option is to take the RMD from other IRA assets, if you have them. In either case, it is important to coordinate with the annuity provider and/or financial advisor to ensure the RMD is calculated correctly.

In some cases, the RMD rules can become complicated when it comes to annuities. For example, if you own a variable annuity within an IRA, the RMD rules can be more complicated than with a traditional IRA. 

The RMD rules for annuities can vary depending on the specific annuity contract, so it is important to carefully review the contract and consult with a financial advisor to ensure you are following the correct RMD rules.

Frequently Asked Questions

Are annuities subject to RMD? 

Annuities are subject to RMD rules, except for immediate annuities.

Do you have to take an RMD from a non-qualified annuity? 

If you own a non-qualified annuity, you are subject to RMD rules once you reach age 72 (or age 70 ½ if you turned 70 ½ before January 1, 2020).

How do RMDs work with annuities? 

RMDs are calculated based on the value of all your retirement accounts, including annuities. You may need to take RMDs from multiple accounts to meet the required amount.

Are annuity payments subject to RMD? 

Annuity payments count towards RMDs, and may satisfy the entire RMD amount depending on the payment amount and frequency.

How much is the penalty for failing to take RMDs? 

The penalty for failing to take RMDs is 50% of the amount that should have been distributed.

I failed to take out RMDs in prior tax years. Is there a penalty? 

There is a penalty of 50% of the amount that should have been distributed.

How can I avoid IRS penalties in the future? 

It is important to plan ahead and ensure you are taking the correct RMD amount each year. Working with a financial advisor and keeping track of your retirement accounts can help you avoid penalties.

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