Buying an annuity in an IRA
Client has $400,000 in a Traditional IRA. He wants to purchase an annuity in the IRA for $200,000, which will be immediately annuitized, and pay out approximately $3,500/month for life. He wants the payouts to stay within the IRA account. Is this allowed? Also, Since the annuitized annuity technically has no market value, how do I calculate the RMD amount for 2011 at the end of this year?
Thanks
Permalink Submitted by Alan Spross on Fri, 2010-04-30 19:24
This is allowed prior to RMDs, but not after RMDs must begin.
Prior to 70.5 a custodial IRA account can be established and a SPIA purchased that pays distributions to the IRA that remain in the IRA. There are no taxes due since no money is distributed from the IRA account. For example, you might purchase a 10 year SPIA when the term ends just before RMDs must begin.
But when RMDs must begin the annuity contract must be separated into it’s own IRA for the reason you cited ie. no account balance exists on which to base an RMD calculation. After the IRA annuity is separated from the other IRA assets, the annuity payout is distributed to the IRA owner and satisfies the RMD for the annuity portion only. The other IRA has an account balance which is used to compute the RMD on that portion in the usual manner using the prior year end account balance.
The partitioning of the IRA into two accounts must be done prior to the year owner reaches 70.5 if the SPIA was purchased prior to that year. But if the SPIA IRA is purchased on or after that year, the RMD for the year of purchase can be figured in the usual manner because there was a full account balance at the prior year end. But the annuity must be split out before the end of that year and it will stand on it’s own for RMDs in future years.
In many cases the insurance company will require a new IRA account for the annuity contract when it is purchased because they are aware of the RMD implications.
An SPIA payout is basically a level amount each year, so it is much higher than the typical RMD for a few years, but perhaps in the early 80s the RMD percentage for the rest of the account exceeds the annuity payout.
This is not a great time to buy an SPIA because interest rates are near a historical low.
Permalink Submitted by Eric Drossner on Wed, 2010-05-05 21:33
thank you very much for your reply. Is there any chance there is an IRS reg that you could guide me to that discusses annuities in IRAs? My client does not believe me that what you have described is correct, and I’d like to point him to a reg.
Thanks again.
Permalink Submitted by Alan Spross on Wed, 2010-05-05 23:41
The following Notice is the only specifics the IRS has released on the subject, and there is nothing included in there that is specifically on point. The client needs to run this by the insurance company, and I would be interested to know where they diverge from my former post, since there were several points made:
http://www.irs.gov/pub/irs-irbs/irb04-26.pdf
Permalink Submitted by Al Fry on Thu, 2010-05-06 16:52
As usual, Alan is Correct. The only exception I can think of is if the annuitization was like two that I have, which are hybrids. In this case the variable income has a 75% resetting floor, guaranteed for life and WITH an acccount balance for several years, during the access period. At the end of the access period (age 100 in my case), there is no balance, then the annuity would be taken out and be its own IRA. The way I am going, I won’t have to worry about that!