9 Replies Latest reply on Dec 31, 2013 10:01 PM by Sharon

    RMD Question

    tmwenner
      Let say I retire with a 1 million dollar nest egg (all tax deferred monies), and took $400k of it and bought an immediate annuity (at age 66). When I turn 70ish, RMD kicks in. Will only the remaining $600k be effected by RMD ? Will the annuity monthly/yearly payments be counted as part of the required minimum distribution for the $600k ? Just trying to understand how RDM works when an annuity is part of one's retirement plan. Thanks in advance for any response. Tom.
        • Re: RMD Question
          MyR Community Manager

          tmwenner, thank you for creating a new discussion thread! We appreciate and enjoy your participation in the MyRetirement.org online community and look forward to your future contributions.

          • Re: RMD Question
            JerryD
            There are a bunch of savy higher ed types over on the TIAA-CREF forum on www.morningstar.com under the "discuss" tab that really understand annuities. You might want to run through this with them.
            • Re: RMD Question
              CurtGufe
              Both annuities and RMD have important consequences on after tax income, surrender of assets, and overall financial security. You should seek advice from a certified financial planner for your specific situation and preferences. 

              I am not a CFP, but I've read a lot and am fairly skilled with taxes and finances. Based on my reading of the RMD rules (IRS), the IRS only cares that the total withdrawals from any of your tax deferred accounts are at least as large  as the required  minimum distribution amount. There is no way to exclude any of your tax-deferred accounts from this. If you paid into those accounts only with before-tax money, then the calculation is quite a bit easier. If you paid in to any account with some after-tax money, the calculation becomes more complicated. Any inherited tax-deferred accounts are beyond the scope of this answer.  Also, in some cases some pre-1987 TDA account balances may be except from the RMD until a later age (75).
               
              If you paid in all the funds into your non-inherited tax-deferred accounts with after tax money, then all the withdrawals are taxable income for US income tax purposes. It seems that this generalization applies to annuities as well. All income from an annuity paid for with pre-tax money will be taxable in the tax year in which it is received.
               
              I'm not sure if the non-taxable amount of principle taken from a defined-contribution account counts towards the RMD, but I doubt it. The whole point of the RMD is about taxation, so non-taxable amounts probably cannot count towards meeting the RMD. But I'm not sure about this. However, the distributions from such accounts are aways considered to be first from earnings and before tax funds (i.e., taxable) and only after those are exhausted is the tax-free principle included in the withdrawals.
               
              Generally, there is an RMD calculated for each defined-contribution account by the company that manages that account. (They will inform you of this. Many - most - offer one or more ways to withdraw just the RMD amount.) You may combine like-type accounts to determine the RMD for that type of account. However, only RMDs from IRAs can be combined, and then only if they are still defined contribution accounts (not annuities). So, IRAs are one type of account and have one total IRA RMD. To meet this requirement, there must be at least the total IRA-RMD amount withdrawn from any of the IRAs. It may be from one account, or from more than one account. For this reason, individuals are often advised to simplify their RMDs by doing rollovers of their TDAs into IRAs.
               
              Other types of qualified plans (tax deferred) have one RMD per account and cannot be combined with the RMDs for other accounts, even of the same type (ie. 401k and 401k). Apparently the IRS allows 403b accounts to be combined like IRAs, which is the sole exception to this rule. So, taking more than the RMD from one account cannot be used to offset the RMD from another qualified plan account (except for 403b accounts). For this reason retirees are often advised to combine all of their qualified plans of any one type into one account of the same type, or to rollover all the qualified plans into one or more rollover IRAs.
               
              The RMD in the above two paragraphs is different than the RMD for annuities. The RMD mentioned above (for defined contribution TDAs) is calculated from the value in the account at the end of the prior tax year.
               
              Annuities fall under the same tax rules as defined benefit pensions. There are several types of payout patterns and they have similar rules with respect to RMD calculations. However, each type of annuity, its payout rules, its payout increase rules, and the purchase age and fraction of after-tax funds used for its purchase make each annuity unique. As far as I can tell, the distributions from each annuity can only be used to meet the RMD for the annuity from which payments are made. By requirements of the IRS, each tax-deferred annuity must pay out at least the equivalent of the RMD (from the perspective of the IRS). One way to look at this is that the annuity payments always meet 100% of the RMD for that annuity, but nothing more than 100% of the RMD and nothing less than 100% of the RMD. Even if some after-tax funds were used to buy the annuity, the taxable parts of the payments would still be considered to meet exactly 100% of the RMD for that annuity.
               
              There is an exception to the above, which is when one buys a deferred annuity with pre-tax funds and the deferral period begins after reaching age 70. In that case, there is an RMD on the value of the account annuity (paid-in tax-deferred principle and earnings) during the deferral period. Typically, these investment products are set up as IRAs during the deferral period. If so, their RMD can be offset with withdrawals from other IRAs, if one owns any. Once these are annuitized (monthly payments start) then they are treated the same as an immediate annuity.
               
              So the impact of using part of one's TDAs to buy an (immediate) annuity would be to remove that part of the TDA funds from the calculation of the RMD for the TDAs. In other words if $400K of $1M in TDAs was used to buy an annuity, there would still be an RMD from the remaining TDA funds (initially valued at $600K). The annuity payments meet the RMD for the immediate annuity but those payments cannot be used to meet the RMD for the remaining TDA funds.
               
              Generally, annuitizing TDAs generally eliminates the RMD issues, but this only applies to the extent of the funds used to buy the annuity. Non-annuitized funds in TDAs still have an RMD. Thus, the "simplifying" effect of buying an annuity does not apply to any funds not used to buy an annuity.
               
              I'm not sure if funds held for part of a year and then used to buy an immediate annuity are subject to RMD for the year in which the annuity is purchased (for the last time). Also, I'm not sure when annuity payments must start to qualify as having met the RMD for the year in which they start. These two issues are related. It seems clear that if payments start by Jan 1 of the year in which one turns 70-1/2, they will meet the RMD requirements for the tax-deferred funds used to purchase the annuity.

              Good luck. I'm not retired yet and am hoping to deplete my TDAs (converting them to Roth IRAs) prior to the beginning of the RMDs. Fortunately, the market seems to be forcing me into the situation where some of my TDAs will remain unconverted after I reach age 70. Unfortunately, I will then have to face these issues.
               

                • Re: RMD Question
                  Sharon
                  This is totally confusing.
                  Guess you have to pay a tax man to figure it out.
                  We are now getting money from an annuity.
                  We paid for it with after tax money.
                  It has gone down in value...meaning, it is worth less than when purchased.  Why do we still have to pay tax on it?
                    • Re: RMD Question
                      CurtGufe
                      I'm sorry if this is confusing. Annuities are highly complex contracts that are really an insurance product that has investment-like properties.

                      The original post was about tax-deferred funds used to buy an annuity and the issue of RMDs for such annuities.
                       
                      In your case, you bought your annuity with after tax money, so there is no RMD, and my earlier post is not relevant to your situation.
                       
                      The reason why you have to pay tax on some of your annuity payments are that there is earnings on the money you used to buy the annuity and those earnings are taxable, just like bond or CD interest. Because annuities are insurance products, the way in which the taxable fraction is calculated is quite complicated, and is done by rules specified by the IRS. Your annuity company should be able to explain that calculation to you. The taxable and non-taxable amounts for each year are shown on the 1099-R sent by the annuity company for you to use to prepare your tax return. But not every $ of all of the annuity payments will be taxable if you used after-tax funds to buy the annuity. If you used $100K of after tax funds to buy the annuity, then $100K of the payments will not be taxed, since they are simply the return of your principle. This is just as if you had a $100K CD - only the interest is taxable income, not the withdrawal of the the $100K you deposited. Although it might seem reasonable that the first $100K in annuity payments (in this example) should not be taxable, that is not the way the calculation works with an annuity.
                       
                      There could be two reasons for the annuity value going down. One is the annuity payments that you are getting every month. Those monthly payments are deducted from the value of the annuity if the annuity payments are for a fixed period (or guarantee period) with a beneficiary. The other possible reason is that your annuity is a variable annuity, with the underlying assets held in investments that can variably increase or decrease in value, such as bond or stock mutual funds. Longer-dated bond funds took a big hit earlier in 2013, enough to make their value go down somewhat.

                        • Re: RMD Question
                          Sharon
                          Thanks.
                          I guess I'm angry because I wanted to pay off our house and not buy an annuity.  My husband bought at the top of the stock market, and it has taken 8 years to catch up to be worth what we put in. He only wanted a stock variable annuity..I could have divorced him. But chose not to.
                          Now he has to take out a monthly sum, and have to pay tax on the non existent profit.  Don't understand that. But the gov. always wants its money.
                    • Re: RMD Question
                      yanushkevich
                      I believe I did just that:  at age 55 I cashed out my all Tiaa and took it as a lifetime annuity;  although I was not 59.5, I was not penalized because I took a lifetime distribution (annuity).  Now I was left with only my Cref.

                      I took some Cref out over the years, but when I turned 70.5, I had to take mandatory distributions on the entire Cref balance.

                      I converted my 403b into an IRA at age 65.  Therefore I lost the possibility to defer mandatory distributions on the value of my Cref in 1987;  that's when the mandatory distribution reg. passed I believe.  Had I kept my 403b, I would have had to  take mandatory distributions only on post 1987 accumulations, until age 76 only.  Of course, by age 76, I would have had to take mandatory distributions on the entire Cref account.

                      So I believe the answer to your question is, YES,  you will have to take mandatory distributions on the entire $600K plus any capital growth in that account when you turn 70.5. 
                      • Re: RMD Question
                        JerryD
                        Tom, I hope never to annuitize any retirement funds. Annuities are very complex and in my opinion take your funds out of your control permanently with little left for beneficiaries (I know about payout options that can extend payments, no need to explain). 

                        If taxes are an issue, one thing that I suggest that you and others consider is to convert retirement funds to a Roth. One does need to pay the taxes but depending on your age and health they may pay back to you and your beneficiaries in no future taxes due. Again, depending on your circumstances you may be able to use excess deductions to avoid taxes. Even unemployment can be an opportunity to convert at no or very low taxes. Having taxable funds available to pay the taxes adds to this approach.

                        Just a thought to consider. Over the years we have sheltered maybe 40% of our retirement funds at a very low tax rate using these principals. We hope to never use these funds except for emergencies with no tax consequences and then leave them to the kids at a zero tax rate.
                        • Re: RMD Question
                          tmwenner
                          Thanks to all for your replies. They were very helpful. Tom.