IRA Annuity Rollover and RMDs

Written by Hersh Stern Updated Saturday, December 7, 2024

Doug S. writes-- I am 73 years old and interested in transferring part of my 401K into a rollover IRA with an immediate annuity. I have two questions:

1.If the immediate annuity payout falls short of my RMD, what do I need to do?

2. If I want my wife to continue receiving the annuity payout, is she considered a joint annuity owner or a beneficiary under IRA rules?

Q1: If the immediate annuity payout falls short of my RMD, what do I need to do?

A1: When you transfer money from your present 401k or IRA account to an insurance company, the insurer creates a Traditional IRA account into which the transferred monies are received and issues an immediate annuity for that account. This is sometimes called an IRA immediate annuity. These monies are no longer considered part of your original 401k or IRA. The annuity is held outside of your present 401k/IRA. In other words, it is not an annuity "owned" by your present IRA.

Now regarding RMDs -- An IRA immediate annuity is considered by the IRS to "automatically" satisfy the RMD requirements for that premium amount as long as the annuity was set up for payments which are life contingent (single or joint life) and/or for a fixed term not to exceed the owner's RMD life expectancy. There is no annual RMD reporting required for such an IRA immediate annuity.

So in your case, you can never "fall short" on RMDS with respect to the premium money that was used to buy the IRA immediate annuity.

But, since you also have additional 401k monies (or IRAs), which were not "annuitized" into an IRA immediate annuity (for example, IRAs with stocks, mutual funds, bonds, money markets, etc.) then you are required to calculate and withdraw RMDs from those other IRA/401k accounts.

A frequently asked question is, can I consider any of the income I received during the year from my IRA immediate annuity to also satisfy in whole or in part the RMDs required from my non-annuity IRA/401k accounts?

The prevailing answer to this question is "NO" -- you cannot aggregate the values of your annuitized IRAs with the non-annuitized or lump sum 401k/IRAs for RMD calculations. There are three reasons for this:

First, an annuitized IRA does not really have a cash value to enter in an RMD calculation. When you buy an immediate annuity you are relinquishing control of the premium to the insurance company in return for an unsecured promise that the company will make certain future payments to you. So you don't own an account with an underlying cash balance. In general, you cannot even withdraw a lump sum payment from your immediate annuity. (Recently, some companies have begun to offer cash advances in their immediate annuity contracts but that has not effected the principle mentioned here.)

The second reason that an annuitized IRA should be excluded from RMD calculations is because immediate annuity payments are typically non-increasing. The same monthly amount paid to you at age 70 is paid to you at age 80 and beyond. The payments, once established, do not change as you get older. RMDs, on the other hand, increase as a proportion of the total value of your IRA holdings as you get older. So there is a unique challenge in fitting level immediate annuity payments into the increasing RMD model. Due to these complexities, the IRS has decided that if you annuitize 401k/IRA monies you are considered to have satisfied RMDs with respect to those funds for your lifetime.

A third, more technical justification for this opinion is that if you transfer part of an existing individual retirement ACCOUNT to an individual retirement ANNUITY; then Defined Benefit ("DB") rules distributions from the annuity apply, while the reduced balance in the IR account subject to RMD's are under the regular Defined Contribution ("DC") rules. Regarding "DB rules" - IRS Publ. 590 says about individual retirement annuities: "If your traditional IRA is an individual retirement ANNUITY, special rules apply to figuring the required minimum distribution. For more information on rules for annuities, see Regulations section 1.401(a)(9)-6..." "DC rules"- the RMD rules for individual retirement ACCOUNTS are the same as the rules for Defined Contribution plans and are explained in IRS Publ. 590; that means, primarily, distributing each year the previous Dec. 31 aggregate fair market value divided by uniform life expectancy.) Since the immediate annuity is considered an individual retirement ANNUITY (not an individual retirement ACCOUNT) its monthly income payments have nothing in common with the RMD for one's individual retirement ACCOUNTS (401ks or IRAs).

The above not withstanding, I occasionally hear from annuity clients that their CPAs were recommending that they "combine" the IRA annuity RMD with their total RMDs for all IRAs and 401ks. The benefit to doing so is that in the earlier years, say between ages 70 and 85, the annuity typically provides an "excess" distribution (an annual amount greater than the minimum amount required under RMD rules). So a CPA might recommend the client apply this "excess" distribution to the RMD required for the non-annuitized IRA assets. The case is further made that even though an immediate annuity has no cash value it still has an inherent fair market value ('FMV'), and, thus, a dollar figure could be assigned to it which when added to the non-annuitized 401k/IRA assets produces a total pre-tax assets valuuation. These clients were advised to apply the annuity payments to cover their non-annuity RMDs.

An argument in favor of this view might be that since an IRA account can invest in and hold an ordinary annuity (through a self-directed IRA custodian) then, you would continue to have RMD's, under the DC rules (mentioned earlier), from that account, on its full value, which includes the Fair Market Value (FMV) of the annuity. In other words, you would combine the FMV present value of the immediate annuity (even though it can not be cashed out) with the value of the remaining pre-tax assets and calculate the RMD on the combined values. Hence, this client was told to subtract the income amounts received during the year from the immediate annuity from the required RMD on the "combined" assets, and only withdraw the difference from the non-annuity assets to satisfy RMDs on all pre-tax values.

If you choose this approach to calculating your RMDs may I suggest that you obtain a confirming written opinion from a CPA or tax attorney, just in case the IRS decides to question your RMD calculation.

Q2: If I want my wife to continuing receiving the annuity payout, is she considered a Joint annuity owner or a beneficiary under IRA rules?

A2: Since an IRA can only have one owner when you apply for the annuity, you name your wife as Joint Annuitant and Primary Beneficiary. We'll help you fill out the application -- that's part of our service.