December 10, 2018 • Retirement 101 / Articles and Insights

What is a Required Minimum Distribution and How Does it Affect Certain Types of Annuities?

You’ve saved and saved for your retirement. At some point, after you retire, you may want to start withdrawing your savings to provide income, or you may choose to leave that money in your savings account or financial vehicle indefinitely.  

Whether you take it out or leave it will not only depend on your financial situation, but also on what type of savings vehicle you have. There are two general types of retirement savings options based on their taxation. The first type is an account or financial vehicle you contribute to with after-tax dollars—the money you declared as income and paid the income tax on. The IRS calls these “non-qualified” accounts.  

The second type is when you contribute money with before-tax dollars—meaning you did not pay income taxes on your contributions when you made them. The IRS calls these accounts “qualified.” Qualified retirement accounts can be sponsored by your employer—like a 401(k) or 403b plan—or individually owned by you. These individually-owned accounts are called IRAs, or Individual Retirement Accounts.

How Does an IRA Work?

An IRA is an account where you keep your retirement savings. It is usually held by a financial institution or brokerage firm, or perhaps an insurance company, if the account is funded with an insurance product. You add money to an IRA by either making a tax-deductible contribution or by transferring money from another qualified retirement account.

Because IRAs are “qualified,” the taxes you owe on contributions and earnings are deferred until a later date.

I Know I Can’t Defer My Taxes Forever—When Do I Have To Pay Them?

Because you haven’t paid any income taxes on the money in your IRA, the IRS decides at what point in the future you must start paying taxes. Today, that means you’re required to begin taking your money out when you turn 70 ½. The hard deadline is April 1 of the year after you turn 70 ½. Each year after that, you’ll need to take money out annually by December 31.

The IRS calls the amount you must take out your Required Minimum Distribution (RMD). Your RMD is determined by the IRS, and is a calculation of how much you must take out each year. The amount you take out is called your distribution.

How Do I Know How Much to Take Out?

Your insurance company, financial institution, or financial professional should be able to tell you how much you must take out of your retirement account each year. The amount is determined by a combination of your age, the balance in your IRA, and, if you are leaving your savings to your spouse, your spouse’s age.

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If you have more than one IRA, you can take the RMD from just one IRA or from multiple accounts, but you must take it, regardless of whether you need the money. If you don’t withdraw the full RMD, you could end up paying a 50 percent penalty of the amount you should have withdrawn.

If you don’t withdraw the full RMD, you could end up paying a 50 percent penalty of the amount you should have withdrawn.

What Other Types of Retirement Savings Plans are Subject to RMDs?

Most retirement savings plans that are defined by the IRS as “qualified” are subject to RMDs, including: 401(k), 403(b), and 457(b) plans; traditional, SEP, SARSEP, and SIMPLE IRAs; and profit-sharing plans.

Annuities and RMDs

An IRA is a popular option for retirement planning. An IRA can include multiple retirement savings strategies, and some people choose to include an annuity as part of their IRA.

Annuities may be a good consideration for IRAs because they offer lifetime guaranteed income and other insurance protections for your savings. There are a wide variety of annuities available to use for IRAs, and some are subject to RMD and others aren’t. All IRAs funded with an annuity are subject to RMDs at age 70 ½, except:

Roth IRA annuities

A Roth IRA is a type of IRA that is funded with after-tax dollars. Because you are paying taxes on the contributions upfront, you get some tax breaks later on. As with a traditional IRA, any interest the Roth IRA earns can grow tax-deferred. However, when you are ready to take income payments, you won’t pay taxes, assuming you are age 59 ½ and the account has been open for at least five years. And because you have already paid taxes on the principal amount, you are not required to take RMDs.

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Immediate Annuities

If you buy an immediate annuity using your IRA savings, your payments will begin immediately—usually within the first year. Because you will already be distributing money from your IRA on a regular basis, you won’t have to worry about the RMD.

Qualified Longevity Annuity Contract (QLAC)

You can also transfer your IRA savings into a qualified longevity annuity contract (QLAC) and defer the RMD on the amount of IRA savings you transfer. There are two important limitations:

  • IRAs with $520,000 or more in value can transfer up to $130,000 into a QLAC. IRAs with less than $520,000 can transfer up to a maximum of 25 percent. The amount you do not transfer (the amount that remains in your IRA) will be subject to RMDs at age 70 ½.
  • You must begin RMDs by age 85 on the amount of money in your QLAC.


Qualified Deferred Annuity Making Payments

If you’ve purchased a Qualified Deferred Annuity (QDA) and have already started receiving payments from the annuity, you are not required to take RMDs. That’s because, like using an IRA to fund an immediate annuity, you’re regularly taking money out.

There are several products and options for you to consider when planning for retirement. Annuities may be an option for your financial situation and offer many benefits not available in other financial products. To find out more, you should talk to a financial professional.

Purchasing an annuity within a retirement plan that provides tax deferral under sections of the Internal Revenue Code results in no additional tax benefit. An annuity should be used to fund a qualified plan based upon the annuity’s features other than tax deferral. All annuity features, risks, limitations, and costs should be considered prior to purchasing an annuity within a tax-qualified retirement plan.
Annuities are long term financial products designed for retirement income and may not be suitable for everyone. They involve fees, expenses and limitations, including surrender charges for early withdrawals. Some include optional riders and benefits that may come at additional cost. Annuity product and feature availability may vary by state.
Annuity guarantees are backed by the financial strength and claims-paying ability of the issuing company. Withdrawals are subject to ordinary income tax, and if take prior to age 59 ½ may be subject to an additional 10 percent federal penalty.

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