Here’s a question I have been getting more and more lately. With the bulk of Americans retirement money in qualified plans such as 401ks and IRAs, it makes sense.
So let’s go through this bit-by-bit and give you some examples:
When you turn 70 ½ Uncle Sam and his buddy the IRS will force you to start taking money out of your IRA or 401k regardless if you want to or not. It’s called the Required Minimum Distribution.
You can read a table for calculating your Required Distribution here.
As a rule of thumb, at 70 ½, it starts right around 3.65% of your IRA account value on December 31st of the year prior to the distribution. The percentage amount goes up as you get older. At age 80 the percentage is about 5.35%. (All based on current IRS tables.) You have been getting tax advantages on your money for the past 20-30 years, and now the government wants some taxes. You MUST take out the required amount every year after you turn 70 ½ or there is a very big penalty. How does this work if I put my IRA / 401k into an annuity?
It depends on the annuity.
Many of them specifically say “RMD friendly”. That means that as long as you are not exceeding your RMD you can take it out every year without penalty, even if the RMD amount exceeds the withdrawal limits set forth in the contract. Many annuities have 10% free withdrawal features and they are also RMD friendly meaning that if your RMD ever exceeds the 10% free withdrawal provision, you can still take the RMD without any penalties. This is a good thing.
So let’s look at some different types of annuities and how the Required Minimum Distribution would work:
Hybrid Annuity (Indexed Annuity with Income Rider): There are a couple different things going on here. So try to follow me.
During the “Roll-up Period” you are letting your income account grow. The longer you let it “Roll Up” the higher your eventual Guaranteed Income will be. If you start your guaranteed income withdrawals BEFORE the age of 70 ½ then the amount of your withdrawal should satisfy your RMD.
EXAMPLE: Let’s say your Guaranteed Withdrawal is $5,500 per year for life. You calculate your RMD to be $3,650. You are good to go that year. The $5,500 is more than your RMD of $3,650, so nothing to worry about.
As you get older, your RMD percentage goes up every year. As long as the amount you are taking out satisfies the RMD amount, then you are fine. You do not have to take out your income plus the RMD.
IMPORTANT: If you don’t plan on starting the income rider payments until after the age of 70 ½ then there may be a few years that you will need to take out your RMD even though you have not started your guaranteed withdrawal payments. In this case, you will need to take out your RMD as a withdrawal. You don’t have to enact the guaranteed income rider payments, but you do need to take the RMD no matter what.
Another option would be to take the RMD from a different IRA account. As long as the total RMD is correct, based on the total amount of IRA/401 money, the IRS does not care if you take it all from one account, or take the RMD from multiple accounts. Just as long as the total is correct.
Depending on the Hybrid Annuity, the Income Account may or may not continue to roll up when you take out your withdrawal for your RMD.
CD -like Fixed Annuities (Also called MYGAs or Fixed Rate Annuities):
This totally depends on the contract.
There are CD-Like Fixed Annuities with zero liquidity, and if you take your RMD you will have to pay a penalty. I’d avoid these if you are using IRA money. There are other contracts that allow you to withdraw only your interest, BUT if the RMD is more than the interest then they will let you take out the RMD. This is a good thing.Then there are Fixed Annuities with 10% liquidity and RMD friendly. With these you have nothing to worry about. There’s plenty of liquidity to take your RMD. Compare that to a bank CD where you may not be able to take your RMD at all without having to forfeit some interest.
Just be sure to ask your advisor or agent if the annuity is “RMD friendly.”
These would work similar to a CD-Like Fixed Annuity.
Let’s assume you put some IRA money in an indexed annuity just to keep it safe, diversify and get some growth potential. Once you reach 70 ½ you must start taking out your RMD whether you want to or not. In most cases, the custodian company will send you letter reminding you about this. They will give you plenty of time and will also help you calculate your RMD. There is usually a piece of paper that you need to sign and submit it to the insurance company for them to process your RMD.
This goes with any of the annuities mentioned.
This one is complicated and I will refer you to a tax professional if you are looking for answers on whether or not the immediate annuity you purchase will satisfy your RMD.
SUMMARY: In most cases, you are fine using IRA or 401k money to fund an annuity and you will be able to take your Required Minimum Distribution without any problems. BUT, make sure you ask the agent or advisor if the annuity is RMD friendly before you transfer any money there. One simple question could save you problems down the road.
Hope this was helpful.
DISCLAIMER: I am not an accountant, lawyer, or tax professional. This article is for educational purposes only. Please consult with the proper professionals to make sure you are doing things correctly.
Click here (Carl Ostenson) to see more of this author’s articles.
P.S. – Please share this article with others by simply clicking on the blue social media icons at the top of your screen!
Annuity123 does not offer insurance, investment, or tax advice. You should always seek the guidance of qualified and licensed professionals concerning your personal insurance, investment, or tax matters. Annuity123 is simply a platform allowing retirement planning professionals to help educate the community on various retirement planning topics. Annuity123 does not directly support or take responsibility for ensuring the accuracy of the content displayed in the articles themselves or any feedback that may get added in the Comments section from the community.