Required Minimum Distributions (RMDs) represent one of the most significant considerations for retirees managing their tax-deferred retirement accounts. When it comes to annuities, the question of RMD applicability creates considerable confusion among investors and financial advisors alike. The answer isn’t straightforward because it depends on several critical factors, including the type of annuity, how it was purchased, and the specific circumstances of the account holder.

Let’s take a closer look at where and how annuities and RMDs intersect…

Understanding required minimum distributions

Before examining how RMDs apply to annuities, it’s essential to understand what RMDs are and why they exist. The Internal Revenue Service requires account holders to begin taking minimum distributions from most tax-deferred retirement accounts starting at age 73 (as of 2023, increased from age 72). This requirement ensures that the government eventually collects taxes on money that has been growing tax-deferred for decades.

The RMD rules apply to traditional IRAs, 401(k) plans, 403(b) plans, and other qualified retirement accounts. The distribution amounts are calculated based on the account balance and the account holder’s life expectancy, using IRS life expectancy tables. Failure to take the required minimum distribution results in a substantial penalty of 25% of the amount that should have been withdrawn, making compliance crucial for retirees.

The complexity of annuities and RMDs

Annuities occupy a unique position in the retirement planning landscape because they can exist both inside and outside of qualified retirement accounts. This distinction fundamentally determines whether RMD rules apply. The key principle to remember is that RMD requirements are tied to the tax status of the account holding the annuity, not to the annuity product itself.

Qualified vs. non-qualified annuities

The most critical distinction when considering RMDs and annuities is whether the annuity is “qualified” or “non-qualified.” This terminology refers to the tax treatment of the money used to purchase the annuity, not the annuity product itself.

• Qualified annuities are purchased with pre-tax dollars within tax-deferred retirement accounts such as IRAs, 401(k)s, or 403(b)s. Since these annuities exist within qualified retirement accounts, they are absolutely subject to RMD requirements. The annuity must begin making distributions by the required beginning date, and these distributions must meet or exceed the calculated RMD amount.
• Non-qualified annuities are purchased with after-tax dollars outside of retirement accounts. These annuities are not subject to RMD requirements because they weren’t purchased with tax-deferred money. The account holder has already paid taxes on the principal used to purchase the annuity, so the IRS has no compelling interest in forcing distributions.

How RMDs work with different types of annuities

Immediate annuities in qualified accounts

When an immediate annuity is purchased within a qualified retirement account, it typically satisfies RMD requirements automatically. Immediate annuities begin paying out shortly after purchase, and if the payment schedule meets or exceeds the RMD calculation, no additional distributions are necessary. However, if the annuity payments fall short of the required minimum distribution amount, additional withdrawals must be made from other qualified accounts to satisfy the requirement.

The IRS provides specific guidance for immediate annuities through the “annuity exception” rule. If the annuity payments are made over the life expectancy of the account holder (and spouse, if applicable) and meet certain other requirements, the payments can satisfy the RMD obligation. The payments must be substantially equal, made at least annually, and continue for the life of the annuitant.

Deferred annuities in qualified accounts

Deferred annuities present more complex RMD considerations. These products allow money to grow tax-deferred during an accumulation phase before beginning distributions. When held within qualified retirement accounts, deferred annuities must begin distributions by the required beginning date, just like any other qualified account asset.

The challenge with deferred annuities is that they’re designed to delay distributions, which can conflict with RMD requirements. Account holders must carefully coordinate the annuity’s distribution schedule with RMD obligations. This might require taking additional distributions beyond what the annuity naturally provides, or it might mean accelerating the annuity’s payout phase to ensure compliance.

Variable annuities and RMDs

Variable annuities, whether immediate or deferred, follow the same basic RMD rules as other annuities. The variable nature of the investment returns doesn’t change the fundamental requirement that distributions must begin at the appropriate age if the annuity is held within a qualified account.

For variable annuities in the accumulation phase, the account value fluctuates based on underlying investment performance. This creates additional complexity in calculating RMDs, as the account balance used for RMD calculations changes with market performance. Account holders must recalculate their RMD each year based on the current account value.

Special considerations and exceptions

The annuity exception rule

The IRS provides specific relief for certain annuity arrangements through Revenue Ruling 2002-62 and subsequent guidance. Under this “annuity exception,” if an annuity within a qualified account provides payments that meet specific criteria, those payments can satisfy RMD requirements even if they don’t precisely match the calculated RMD amount for each year.

To qualify for this exception, the annuity payments must be substantially equal, made at least annually over the life expectancy of the participant, and begin by the required beginning date. The total payments must be expected to satisfy the minimum distribution requirements over the participant’s lifetime.

Spousal considerations

When a spouse inherits a qualified annuity, special rules may apply. The surviving spouse can often roll the inherited annuity into their own IRA, potentially delaying RMDs until they reach age 73. Alternatively, they might choose to remain a beneficiary and take distributions based on their own life expectancy.

The SECURE Act of 2019 significantly changed inheritance rules for retirement accounts, including annuities. Non-spouse beneficiaries now generally must withdraw the entire account within 10 years, though certain exceptions apply for eligible designated beneficiaries.

Roth IRAs and annuities

Roth IRAs are not subject to RMD requirements during the account holder’s lifetime, regardless of what investments they contain. Therefore, an annuity held within a Roth IRA would not trigger RMD obligations. However, beneficiaries of inherited Roth IRAs may face distribution requirements.

Practical strategies for managing annuities and RMDs

Coordination with other retirement assets

Retirees with annuities in qualified accounts must consider their entire retirement portfolio when planning for RMDs. If an annuity provides payments that exceed the RMD requirement, the excess can potentially satisfy RMD obligations from other IRAs, depending on the specific account types and circumstances.

This coordination requires careful planning and often professional guidance. The IRS aggregation rules allow RMDs from multiple IRAs to be taken from any single IRA, but similar flexibility doesn’t exist for all account types. For example, RMDs from 401(k) accounts generally must be taken from each individual account.

Timing considerations

The timing of annuity purchases and distributions can significantly impact RMD compliance. Purchasing an immediate annuity close to the required beginning date can help ensure that payments begin promptly and meet RMD requirements. However, market conditions, interest rates, and personal financial needs should all factor into this timing decision.

For those with deferred annuities approaching the RMD age, it’s crucial to evaluate whether the annuity’s natural payout schedule will align with RMD requirements. If not, modifications to the annuity or additional distributions from other accounts may be necessary.