Variable annuities are insurance contracts that provide tax-deferred growth of assets that can later generate a guaranteed income stream, thus making them popular vehicles for financing retirement. Like other investment products, variable annuities can be held as either qualified or non-qualified for tax purposes.
Qualified contracts—those held in IRAs or other tax-advantaged plans, like 401(k)s—are subject to the same required minimum distribution (RMD) rules as other investments in qualified retirement plans. Non-qualified contracts offer tax-deferred growth of after-tax funds and have no required withdrawals until annuitization, as defined by the annuity's contract.
Roth IRAs have no minimum distribution requirement until after the death of the account owner. A surviving spouse who inherits a Roth IRA is not subject to required minimum distributions. All other beneficiaries of inherited Roths are required to take distributions, either based on their own life expectancy or the five-year rule.
- Qualified variable annuities held in IRAs are subject to the IRS required minimum distribution (RMD) requirement.
- At age 72 (or 73 starting in 2023), qualified account owners are required to begin taking RMDs from their traditional IRAs.
- Roth IRAs are not subject to RMDs while the account owner is alive.
- A 25% penalty may be assessed on untaken RMDs.
Effects of Required Distributions
The Internal Revenue Service (IRS) generally requires owners of IRAs and other qualified retirement accounts to begin taking withdrawals once they reach the age of 72 (or 73 starting in 2023). The amount of this RMD is determined by an age-based divisor and the balance in the account. A hefty penalty of 25% is imposed if the minimum is not withdrawn, but this penalty can be reduced to 10% if corrected promptly.
Under certain circumstances, the penalty may be waived if the account owner can show the IRS that not taking the payment was due to error and that they are doing what is necessary to remedy the error. The account owner must submit a letter of explanation along with IRS Form 5329.
Having to take withdrawals can create fear for retirees as life expectancies lengthen and the possibility of outliving retirement savings increases. The guaranteed lifetime income rider available for purchase on some variable annuity policies can help solve this problem.
RMD Effects on Benefits
Distributions can negatively impact investment performance and sometimes other benefits to the annuity contract, such as lifetime income riders and death benefits. When evaluating a variable annuity for qualified monies, it is very important to understand how RMDs are treated and the effect they have on the policy.
For example, when MetLife sold annuities, it offered the Guaranteed Minimum Income Benefit Plus rider on its qualified contracts. This benefit treats RMDs as a percentage withdrawal against the guaranteed income base and not the total account value. This helps to maintain the investment's ability to grow.
Required distributions should not stop investors from considering the valuable benefits offered by variable annuities. Investors and financial planners should work together to find a contract that works well with RMDs to maximize investment growth to last through retirement.
How Do You Calculate the RMD on an Annuity?
Annuities are generally not subject to RMDs unless the annuity is held in a qualified retirement account such as an IRA. If you are 72 or older (73 in 2023) and need to take an RMD, you must first consult the life expectancy tables published by the IRS each year. In order to calculate the necessary RMD, divide the value of the account (as of Dec. 31 for the year in question) by the distribution period in the appropriate table.
What Is the Value of a Annuity?
When it comes to calculating RMDs for annuities, the value calculation depends on what type of annuity you have. For deferred annuities, the RMD is calculated based on the value of the annuity contract at the close of business at the end of the year. For annuitized contracts, the cash flow from the annuity is considered sufficient to meet the contract's RMD requirements for that year.
When Is an Annuity Considered Annuitized?
An annuity is considered annuitized when the investment is converted into a steady stream of income payments. Once an annuity is annuitized, the value of the annuity is no longer included in future RMD calculations.