How are IRA Annuity RMDs Calculated After Life Annuitization?

By Jeffrey Levine, Director of Retirement Education
Follow Me on Twitter: @IRAGuru4EdSlott

The IRA rules are very complicated. The RMD (required minimum distribution) rules are very complicated. Annuity rules are very complicated. Put them all together and what do you get? Usually, just a mess of chaos and confusion. Today, we look at what happens to RMDs when you annuitize your IRA annuity over your lifetime or over a joint lifetime (your lifetime, plus the lifetime of another person). The answer provided below is excerpted from our soon-to-be-released must-have resource, The Definitive Guide to Required Minimum Distributions for Baby Boomers. You can purchase the downloadable guide here.
 

RMDs After Lifetime (Joint Lifetime) Annuitization

Although there are still certainly some vagaries with regard to certain issues, most experts agree that the rules are fairly straightforward when it comes to annuitizing an IRA annuity over an IRA owner’s lifetime or over the joint lifetime of the IRA owner and another person. In such cases, once the IRA is annuitized, it generally transitions from following the rules for defined contribution plans to following the rules for defined benefit plans, like pensions.

When a client has a pension and receives a monthly benefit, you don’t generally think about calculating the required minimum distribution for the pension, or for that matter, using distributions from the pension to offset required minimum distributions for other retirement accounts. That’s because whatever distribution your client is receiving from their pension is the RMD for the pension. No higher, no lower.

The same is true for an IRA annuity that has been annuitized over a lifetime or joint lifetime. Once that annuitization has occurred, the general rule is that the distributions produced by the contract are the RMDs for the contract. Thus, there is no shortfall or “excess” RMD taken that can be used to offset the required minimum distribution for other IRAs (other than a possible exception in the year the annuitization takes place, as discussed below).

Example:
Ron has only one IRA, with a $100,000 balance, that he annuitizes over his life expectancy. What’s his RMD? Here, the answer is simple. The annuitized payment that is distributed from the IRA each year satisfies Ron’s RMD obligation.

What if, on the other hand, Ron, age 73, has two IRAs, IRA “A” and IRA “B?” IRA “A” has $100,000 and IRA “B” has $90,000 for a combined value of $190,000. Ron annuitizes IRA “A” over his lifetime and starts to receive $9,000 a year.

Assume that Ron would have a total RMD of around $8,000 for his IRAs this year if he hadn’t annuitized any part of his $190,000 IRA balance. Will the $9,000 he receives from the annuity satisfy the total RMD for all of Ron’s IRAs for the year? Here’s where it starts to get murky.

There is some debate over whether or not such a distribution from an annuitized annuity can be used to satisfy RMDs for other IRAs in the year of annuitization. On the one hand, once annuitized, IRA annuities generally follow defined benefit plan rules instead of the defined contribution rules. That would lead you to believe the answer is no. On the other hand, RMDs are based on prior year-end balances. Since the annuitized annuity had a prior year-end balance and wasn’t annuitized at the time, that might lead you to believe yes (which is the view supported by most, but certainly not all experts in the field). In light of the grayness in this area, the most conservative approach is to take the $9,000 annuity distribution from IRA “A” and an additional distribution from IRA “B” based on its prior year-end balance.

After the year of annuitization, things get much clearer. Nearly all experts agree that there is no way to use the income from the annuitized annuity in IRA “A” to offset any of the RMD that must be taken from IRA “B.” In this situation, the annuity payout will only satisfy the RMD for IRA “A.” Put another way, under the defined benefit plan rules that the annuitized IRA now falls under, the annuity payment is the RMD for that IRA account. The RMD for IRA “B” – with a total value of $90,000 – will be around $3,800 in this example.

Remember, once an IRA is annuitized, there’s generally no prior year-end balance available from the insurance company for computing an RMD. Thus, a client’s other IRAs only will be used for that calculation. Advisors with clients who are thinking about annuitizing a portion of their IRAs should make this clear before the clients act.

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