Calculating RMDs for IRA annuities: 2 scenarios

Some of the most confusing IRA annuity RMD issues arise when a client annuitizes an IRA annuity contract. Some of that confusion stems from the fact that the IRS offers little guidance in some of these areas and thus a lot is left up to interpretation.

When annuitizing, a client makes an irrevocable election to receive a guaranteed income stream over a number of years, a lifetime, or a joint lifetime. With regard to annuitized IRA annuities, there are two possibilities. Either the IRA annuity contract is annuitized so that:

Payments will continue for no less than the lifetime of the IRA owner (or possibly over a joint life expectancy); OR

Payments will be made over a specific number of years only (i.e., 5 years, 10 years, 20 years, etc.)

RMDs after lifetime (joint lifetime) annuitization

Although there are still vagaries with regard to certain issues, most experts agree that rules for annuitizing an IRA annuity over an IRA owner’s lifetime or over the joint lifetime of the IRA owner and another person are straightforward. In such cases, an annuitized IRA 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 about using distributions from the pension to offset required minimum distributions for other retirement accounts. That’s because whatever distribution your client is receiving from a 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, distributions produced by the contract are the RMDs for the contract. Thus, no shortfall or excess RMD taken 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, which 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, however, 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 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 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 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.