Are Annuities Subject to Required Minimum Distribution? (Annuity RMD Rules)

Annuities are a great product for building net worth, deferring tax payments, and guaranteeing income for life. They can be very helpful for you in retirement, providing you with the financial security you need to live out your golden years carefree.

But how long can this money sit, and is there a certain age that you must start withdrawing from your annuity?

Some retirement accounts require that you take minimum distributions once you reach a certain age.

When the time comes for you to begin withdrawing money from retirement accounts, you’ll want to know the rules as they apply to these products.

Let’s review the government requirements regarding when you must begin to take distributions from your retirement accounts.

What are Required Minimum Distributions?

Required minimum distributions (RMDs)are mandatory withdrawals that apply to certain retirement savings accounts.

The accounts that come with RMDs are known as "qualified" retirement accounts.

In other words, these are accounts that you funded with pre-tax money. The internal revenue service (IRS) requires RMDs to ensure you start paying taxes on your pre-tax accounts

Which Accounts Are Subject to RMDs?

It is important to note that RMDs apply only to qualified retirement accounts, including:

• Qualified Annuities
• Traditional
• IRAs
• Simplified Employee Pension IRA (SEP)
• 401(k) Plans
• 403(b) Plans
• 457(b) Plans
• Profit-Sharing Plans
• Defined Benefit Pension Plans

Non-qualified accounts are not subject to IRS RMD rules. The following are examples of non-qualified accounts:

• Non-Qualified Annuities
• Roth IRA
• Non-Qualified Retirement Plan
• Checking and Savings Accounts
• Stocks, Bonds, and Mutual Funds (Individually-Owned)

When Do RMDs Start?

Before 2020, all retirees had to begin taking their first RMD at age 70½. In 2020, the SECURE Act changed that. If you were born before July 1, 1949, your RMD age is still 70½.

However, if you were born on or after this date, the first year you have to take RMDs is now 72. You can access the official IRS guidelines for RMDs by clicking on the link.

Are There Penalties for Not Taking RMDs?

The IRS requires you to begin withdrawing around 3.5% from your qualified accounts at the dictated age.

If you don't, you could be subject to severe penalties—sometimes as high as 50%!

It’s common for retirees to have multiple retirement accounts and lose track of the account type, location, and balance. That's why it is important to keep a log of all accounts.

Being unorganized is not a valid excuse, and the IRS penalty of 50% could be detrimental to your personal finance goals.

For example, if you were required to withdraw $10,000 from your IRAs and failed to do so, the penalty could be as high as $5,000!

In addition, once you do take the RMD, you're responsible for federal income taxes on the $10,000 RMD amount. You must coordinate the total annual distributions from your IRA accounts. But there could be a way around RMD penalties.

Any IRA monies converted into an immediate annuity are not subject to RMD penalties.

We discuss this further in the article. Also, the RMD amount is what you must take from your qualified accounts in total.

You do not need to take it from each account.

Annuity RMD Rules

Annuities have surrender charges, which are fees for withdrawing from the annuity before the end of the surrender charge period.

Sometimes, the surrender charge period coincides with an annuity owner's required minimum distribution period.

Most annuity companies recognize this unique scenario and will waive surrender charges if the RMD amount is larger than the penalty-free withdrawal.

If you do not want to take your RMD because you don't need the income, there's good news. You can actually leverage your annuity and life insurance to maximize an estate plan for your beneficiaries.

The concept is to take the RMD and preserve the original investment by either:

• Transferring the RMD into an annuity that has enhanced death benefits, or;
• Paying life insurance premiums with RMDs

Because the rules can be complex, it’s a good idea to seek advice from a financial professional.

But using creative strategies for maximizing the value of RMDs can be advantageous for you and your heirs.

RMD Rules for Deferred Annuities

If your annuity is held inside an IRA or other tax-deferred account, it is subject to the same RMD requirements.

So yes, your IRA annuity is subject to required minimum distributions. However, non-qualified annuities (funded with after-tax money) generally have no obligation to withdraw funds at any age unless required by the annuity contract itself.

What are qualified longevity annuity contracts?

Suppose you're at the end of your deferred fixed annuity or variable annuity contract, and you are not ready to annuitize your annuity.

You're also wanting to defer taking your RMDs. In this case, a qualified longevity annuity contract (QLAC) may be a good option. A QLAC can help you defer RMDs, save on income taxes, and save for longevity costs.

Here’s how it works: The qualified part of the QLAC means the annuity has met the government requirements for special treatment when purchased with retirement account funds.

This allows you to receive preferential tax treatment. And it comes with the understanding that by age 72 (or 70½), you must begin taking a minimum amount of retirement income from the account every year and pay ordinary income tax on those withdrawals.

But you can spend up to $135,000 of your retirement funds on a QLAC without it counting as a currently taxable withdrawal. You’ll only start paying taxes on that amount when your annuity payouts begin.

Longevity refers to the chief purpose of a QLAC: making sure you don’t outlive your money. With this unique product, you can purchase it now and defer payments until as late as age 85.

The annuity contract part of QLAC shows that you are buying an annuity. The company you buy the QLAC from sends you regular income payments.

These payouts are based on factors such as your initial premium, the guaranteed growth percentage, and the date you want to start receiving payments.

The longer you wait to start receiving monthly payments, the larger your annuity payments will be. That’s the beauty of this type of annuity.

Since everyone’s financial situation is unique, you should work with a tax professional to determine if a QLAC might be an appropriate product for you to use to defer RMDs.

RMD Rules for Immediate Annuities

With an immediate annuity, a lump sum is immediately converted into a guaranteed income stream.

This conversion (which is considered irrevocable) happens through a process called "annuitization." Once an annuity is annuitized, it is not subject to RMDs. Additionally, when an annuity in an IRA or 401k is annuitized, the value of the annuity is no longer included in future RMD calculations.

The IRS considers annuitization as satisfaction for future RMDs. This treatment for RMDs is unique to immediate annuities.

Why are immediate annuities "exempt" from RMDs?

There are two reasons for this: First, the nature of an immediate annuity means that it does not have a cash value to use in an RMD calculation. When you buy an immediate annuity, you are essentially moving money to an insurance company for a promise of guaranteed income.

You no longer own the account that was previously subject to the RMDs. A second reason is the nature of immediate annuity payments. Immediate annuity income is commonly a "flat" payment stream—the payments do not change as you get older.

And RMD rules say that payments are required to increase as you age. Therefore,the IRS could not fit the immediate annuity payments structure into the established RMD model.

RMD Frequently Asked Questions (FAQs)

The following are some of the most common RMD questions we hear:

How are RMDs taxed?

RMDs are taxed as ordinary income. They are not eligible for capital gains tax treatment.

Is it possible to withdraw from my IRA accounts prior to my RMD age?

Yes! You can take withdrawals from your IRA accounts at any point after the age of 59½. If you withdraw money earlier than 59½, the IRS will hit you with a penalty of 10%.

If I have several 401(k) plans, do I need to consider the balances in those accounts when calculating my annual RMDs?

Absolutely. All distributions made from qualified plans (including IRAs and 401(k)s) count toward your annual RMD requirement. This is why it’s so important to keep a log of all retirement savings accounts, especially qualified retirement plans. To find out more, check out our article on the difference between annuities and 401(k)s.

Final Thoughts on Annuity RMDs

As you begin your retirement planning journey, it is important to meet with a licensed financial planner.

They can help you review all of your financial holdings, including tax-deferred annuities, defined contribution plans, and other taxable and non-taxable investments. It is definitely worth your time to understand these products' distribution requirements and distribution periods as well as the taxes on annuities.

This can help you avoid RMDs and penalties. It can also help you maximize your retirement savings nest egg so you can enjoy a comfortable retirement.

If you are still in the process of building that nest egg, you may want to check out Canvas annuities.

We offer very competitive rates and flexible terms that can help grow your nest egg, providing you with a secure retirement.