Do Annuity Payments Count Towards RMD?
Understand how annuity payments factor into your RMDs. The rules for satisfying distributions depend on your annuity's account type and payout status.
Required Minimum Distributions, or RMDs, are mandatory annual withdrawals from certain retirement accounts that individuals must start taking once they reach age 73. An annuity is a contract with an insurance company that provides a stream of payments, often used for retirement income. A common question for retirees is how these two financial tools interact, specifically whether payments received from an annuity can fulfill the IRS-mandated RMD for the year. The answer depends on the type of annuity and where it is held, as the rules differ for annuities inside tax-advantaged retirement plans compared to those held separately.
RMD Rules for Annuities Held Within a Retirement Account
Annuities held inside a tax-deferred retirement account, such as a Traditional IRA or a 401(k), are known as qualified annuities. These are subject to RMD rules, and their treatment depends on whether the annuity has started making regular payments.
Before an annuity is annuitized, or begins paying out, it is in an accumulation phase. During this period, the annuity’s fair market value as of December 31 of the preceding year is included with all other assets in that retirement account. This total value is then used to calculate the RMD for that year.
Once the annuity enters the payout phase, the treatment changes. The payments you receive from the annuity during the year satisfy the RMD obligation for that annuity’s value. For example, if the RMD for the annuitized contract is $5,000 and it pays out $6,000, the RMD for that portion of your account is met.
Treatment of Non-Qualified Annuities
A non-qualified annuity is one purchased with after-tax dollars and held outside of a tax-deferred retirement account like an IRA or 401(k). The rules governing these financial products are distinct from their qualified counterparts, particularly concerning required distributions.
Payments from a non-qualified annuity do not count toward the RMD for any of your retirement accounts. RMDs are a mechanism to ensure that individuals eventually pay taxes on savings held in tax-deferred accounts. Since non-qualified annuities are funded with money that has already been taxed, they are not subject to RMD rules.
These annuities have their own tax structure governed by the exclusion ratio. This calculation determines what portion of each payment is a tax-free return of your initial investment and what portion is taxable earnings. Because this tax treatment is separate, distributions from a non-qualified annuity operate independently and cannot satisfy RMDs.
Calculating the RMD with an Annuity
The procedure for calculating your RMD changes based on whether the annuity within your IRA is in its accumulation phase or has been annuitized. Each scenario requires a different approach to ensure the correct amount is withdrawn.
RMD with a Non-Annuitized Annuity
When your IRA holds a non-annuitized annuity, its value is part of the RMD calculation. First, determine the annuity’s fair market value as of December 31 of the previous year, which is provided by the insurance company on a year-end statement.
Next, add this market value to the value of all other assets held within that same IRA to get the total account balance. You cannot include balances from other IRAs unless applying the aggregation rule after calculating each account’s RMD separately.
Finally, divide this total IRA balance by the distribution period factor from the appropriate IRS life expectancy table, such as the Uniform Lifetime Table. The result is the RMD for that IRA for the year, which must be withdrawn from the account by the annual deadline.
Accounting for an Annuitized Annuity
If an annuity within your IRA has been annuitized, the calculation is different. First, determine the total payments scheduled from that annuity for the calendar year. This annual payment amount satisfies the RMD obligation for the portion of the IRA represented by the annuity.
If the IRA contains other assets besides the annuitized contract, you must perform a separate RMD calculation for them. Find the year-end value of the non-annuitized assets and use the IRS life expectancy factor to calculate the RMD for that portion of the account. This amount must be withdrawn from the non-annuitized holdings.
Regulations allow for flexibility when annuity payments exceed the required amount. If payments from your annuitized contract are greater than the RMD for that annuity, the excess can help satisfy the RMD for the retirement account holding it. This surplus may also be applied toward the RMDs of your other IRAs.