Required Minimum Distribution (RMD)

Written by Hersh Stern Updated Sunday, January 29, 2017

required minimum distribution

At age 70-1/2 you are required to begin withdrawing a certain percentage of your pre-tax IRA or 401k accounts each year in order to pay income tax on the amounts withdrawn. This is known as the annual Required Minimum Distribution ("RMD"). The rules governing RMDs can be found on the IRS's web site: Retirement Plans FAQs regarding Required Minimum Distributions. In this article, I review how RMD rules apply to immediate annuity contracts.

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We'll begin with an email I received recently.

Immediate Annuities and Required Minimum Distributions

Q. Dear Hersh, I am 70 years old. I recently transferred $100,000 from my $300,000 traditional IRA to buy an immediate annuity. Yesterday, I received my first payment from the insurance company. I have a question about how to calculate my RMD since I'll be 70-1/2 soon. Do I combine the $100,000 I transferred to the annuity with my $200,000 IRA or is the annuity separate from my RMD? Thank you. Joe W.

A. Dear Joe, The first thing you need to know is that the RMD rules I'll be reviewing with you are different for different types of annuities. There is one set of rules for pre-tax IRA or 401k monies which you use to buy an immediate annuity, and another set of rules for pre-tax monies which you may use to invest in other types of annuities. I'll explain.

An immediate annuity is created when a lump sum premium is irrevocably converted into a periodic income stream say, for your lifetime. The operative words here are “irrevocably converted." In this case the premium is said to be "annuitized." When an IRA or 401k is annuitized you no longer include the premium or "value" of that annuity in future RMD calculations. The IRS considers such an IRA immediate annuity to have satisfied future RMDs (that is, only with respect to the amount of premium which was used to buy that IRA Annuity). I'll have more to say about this later.

This treatment for RMDs is unique to immediate annuities. If you owned or bought a type of annuity which did have a cash balance account or cash value, for example, a variable deferred annuity or a fixed index annuity, then the cash amounts in that annuity would be subject to RMDs. This is true for as long as the cash value has not been irrevocably converted into an income stream under the contract’s annuitization clause.

Why are immediate annuities "exempt" from RMDs?

There are two reasons for this:

First, an annuitized IRA does not have a cash value to enter in an RMD calculation. When you buy an immediate annuity you relinquish control of the premium to the insurance company in return for an unsecured promise that the company will make certain future payments to you. You no longer 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.)

A second reason why the IRS has determined that an annuitized IRA should be excluded from RMD calculations is because of the level-nature of immediate annuity payments. An immediate annuity income stream is usually a non-increasing payment stream. The same monthly amount paid to you at age 70 is paid to you when you reach 80 and beyond. The payments, once established, do not change as you get older. RMD distributions, on the other hand, are required to increase as a proportion of the total value of your IRA holdings as you age. So there is a unique challenge in fitting level immediate annuity payments into an increasing RMD model.

A hypothetical RMD calculation for an immediate annuity

Let's look at an example to see why RMDs would not work for an immediate annuity.

If you transferred $100,000 to the IRA annuity at age 70 you may receive $7,000 a year, or 7% of the premium in annual income (you can get an instant calculation of the annual income on our home page). But at age 70 the RMD table calls for only a 3.5% annual distribution, which is just $3,500.

How To Calculate Your Required Minimum Distribution

Find your IRA balance from December 31st of the previous year. Divide this amount by the distribution period found on the chart below using the age you will turn on your birthday this year. This is your RMD amount for this year.

Example: If your IRA balance was $100,000 and your age is or will be 75 this year, you would divide the balance by 22.9. Your RMD for this year would be $4,366.82. You can find the IRS worksheet here.

Age Distribution
Period
Age Distribution
Period
Age Distribution
Period
70 27.4 86 14.1 102 5.5
71 26.5 87 13.4 103 5.2
72 25.6 88 12.7 104 4.9
73 24.7 89 12.0 105 4.5
74 23.8 90 11.4 106 4.2
75 22.9 91 10.8 107 3.9
76 22.0 92 10.2 108 3.7
77 21.2 93 9.6 109 3.4
78 20.3 94 9.1 110 3.1
79 19.5 95 8.6 111 2.9
80 18.7 96 8.1 112 2.6
81 17.9 97 7.6 113 2.4
82 17.1 98 7.1 114 2.1
83 16.3 99 6.7 115 1.9
84 15.5 100 6.3    
85 14.8 101 5.9    

So at age 70 the immediate annuity could be said to "over distribute" a larger share of your $100,000 than is required if you left the $100,000 in an IRA money market account. Now the annuity will continue to pay you $7,000 a year, equivalent to 7% of your initial premium, for the rest of your life. Yet, the RMD table does not require a 7% withdrawal from IRA holdings until you reached age 85.

Of course,if you live beyond age 85 those same 7% ($7,000) level annual payments generated by the annuity would no longer keep pace with the annually increasing percentage of IRA assets that the RMD tables required.

So, due to these complexities, the IRS has decided that if you annuitize your IRA monies you are considered to have satisfied RMDs with respect to those funds.

(The IRS regs that stipulate premium dollars which were used to purchase an immediate annuity are not included in any future RMD calculations are difficult to wade through but the reference is here. These regs apply to distributions of an IRA or 401k paid in the form of periodic annuity payments for the owner’s or beneficiary’s life (or the joint lives of the owner and beneficiary) or over a comparable period certain and where the payments are nonincreasing. This is the definition of a fixed immediate annuity contract.)

What about RMDs in the year in which I buy my annuity?

In the year in which you buy your immediate annuity you do have a unique obligation to calculate RMDs. While you won't have to calculate RMDs with respect to the premium that you spent on your annuity in all other years, in the year in which you buy your annuity, however, you must be sure there's no shortfall in the RMD.

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Here's how to go about it: add up all the monthly payments you received (or, are expected to receive) from the annuity in the first year and subtract that amount from your total required minimum distribution obligation for that premium amount in that year. You must make up any required minimum distribution shortfall from other lump sum (non-annuitized) IRA or 401k accounts you own.

Sometimes, it's easier to take care of the first year's RMD by simply removing the full RMD amount from the IRA lump sum before you convert it into an immediate annuity. That way you know you've satisfied RMDs with respect to that money for the complete first year.

Are there penalties for not taking RMDs?

The IRS requires you to begin withdrawing around 3.5% from your IRAs upon reaching age of 70-½. Failure to do so can result in steep penalties, as high as 50%. The Treasury Inspector General recently reported that as many as 250,000 tax payers fail each year to withdraw the required amount from their IRAs.

Why are so many retirees failing to meet the IRS’s required minimum distribution (RMD) withdrawals?

In most cases, retirees fail to withdraw the required funds from their IRA’s annually by accident. In some cases, multiple accounts spread across multiple financial institutions could play a part in this growing trend. Or, these tax payers may have simply incorrectly calculated the amount to withdraw for the given year. In any event, it's important you don't forget to withdraw the correct amount.

This FAQ reviews some of the important aspects of RMDs you may not have heard about.

How much is the penalty for failing to take RMDs?

Currently, the IRS can assess a penalty as high as 50% of the amount that should have been taken out. For example, if you were required to withdrawal $10,000 from your IRAs and you failed to do so, your IRS penalty could be as high as $5,000! In addition, you will be responsible for federal income taxes on the $10,000 amount once you do take the RMD.

I failed to take out RMDs in prior tax years. Is there a penalty?

Yes. There is no statute of limitations on how far back the IRS can look for RMD mistakes. If you have discovered mistakes in prior year’s withdrawal amounts, correct those figures immediately.

If you can provide evidence that you made a reasonable mistake when calculating distributions for prior years, the IRS does have the ability to waive penalty fees. The most common reasons considered for waiving fees include serious illness or dementia.

How can I avoid IRS penalties in the future?

The most important thing to do is accurately track all of your IRA accounts at various firms. Your total annual distributions from these IRA accounts must be coordinated. Of course any IRA monies you've converted into an immediate annuity would not be subject to or trigger RMD penalties.

More RMD FAQs

Q: How are RMD’s taxed? A: RMD’s are taxed as ordinary income.

Q: Is it possible to take withdrawals from my IRA accounts prior to the age of 70 ½? A: Yes, you can take withdrawals from your IRA accounts at any point. However, distributions taken prior to you reaching the age of 59 ½ are subject to an IRS early withdrawal penalty of 10%.

Q: I have several 401k plans still with former employers. Do I need to consider the balances in those accounts when calculating my annual RMD’s? A: Yes. Distributions made from qualified plans and/or IRAs count toward your annual RMD requirement.

Q: How do I calculate the amount I owe in RMD’s each year? A: Your annual required minimum distribution amount is based on your age and your total investable qualified assets. Locate the divisor number (in the RMD table on this page) for your age. Divide the total amount you have invested in qualified plans and IRA accounts (except immediate annuities) by this divisor number. This will be your RMD withdrawal amount for this tax year.

Q: I am married. Will my spouse’s age impact my RMD amount? A: Your spouse’s age can impact your required minimum distribution amount; for example, if he or she is listed as your IRA account’s sole beneficiary or is more than 10 years younger than you.

Q: I have multiple IRA and 401k accounts, each with a different cost basis. Does my cost basis impact the amount owed in RMD’s? A: Generally the term "cost basis" should not apply to IRA or 401k accounts. Cost basis, also called tax basis, refers to the amount of after-tax money you invested and is used to calculate if you have a taxable gain when you sell the investment.

Typically, contributions to an IRA or 401k are made with pre-tax money. So there is no cost basis. However, if you made nondeductible contributions with money on which you already paid taxes you shouldn't be taxed again when you withdraw them. Best, to consult a CPA for detailed instructions on how to handle RMDs when there is a cost basis.

More Coverage: IRS Boston College

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Comments (27)

  1. Harry Davids:
    Nov 19, 2014 at 03:51 PM

    If I roll over 401k or IRA funds into an immediate annuity at age 75, will the annuity payments count as Required Minimum Distributions? Based on your web site calculator, it appears that the annuity payout rates exceed the minimum amounts per the IRS RMD tables.

  2. Hersh Stern:
    Nov 19, 2014 at 03:52 PM

    Hi Harry-

    When you "annuitize" an IRA or 401k lump sum (even a partial annuitization of a portion of your total IRA/401k holdings) that money (meaning the premium paid for your annuity) no longer needs to have RMDs calculated each year. That premium is considered to have satisfied RMDs for your remaining lifetime. This is true in all years FOLLOWING the first year (i.e., the year in which you bought the annuity). In that first year only, you must calculate whether the annuity distributions for that partial year rose to the level that your RMDs would have been had you not purchased the annuity. If they don't, then you need to make up the difference by withdrawing money from other IRA/401k accounts sufficient to cover all your IRA/401k account values as if you had not purchased the annuity that year.

    Regarding your observation that it "appears that the annuity payout rates exceed the minimum amounts per the IRS RMD tables," you are again right. As a general rule, you'll find that by converting a portion of your IRA/401k sum lump into an immediate annuity you always receive more money from the annuity in the earlier years than you would have been required to withdraw from the lump sum to satisfy RMDs had you not purchased the annuity. The reason is that the immediate annuity pays a level amount each year, while RMD withdrawals increase each year (given an unchanging account balance). Rest assured that at some point, the annuity will be paying you less per year than the amount you would have needed to withdraw under RMD rules had you not bought the annuity. In the end it all balances out, so to speak.

    Take good care.

    Hersh

  3. Carol:
    Dec 18, 2014 at 05:38 PM

    1) Let me see if I understand RMDs with annuities. Say I have 200K in an IRA. On June 1, I purchase an immediate annuity for 100K, leaving 100K in my IRA. At the end of the year, my RMD obligation would be the RMD for 200K for six months plus the RMD for 100K for six months. Correct?

    2) Is it better to purchase an immediate annuity out of IRA funds or non-IRA funds?

  4. Hersh Stern:
    Jan 22, 2015 at 09:32 AM

    Hi Carol-

    Nice to hear from you. I’ll answer your questions to the best of my knowledge but I strongly advise you to consult a tax attorney or CPA for an opinion on which to rely. Mine is not a qualified legal or tax opinion.

    What you described in your first question is a “partial transfer” of your IRA from its current custodian to an insurance company IRA. Generally, when you buy a lifetime immediate annuity using IRA or 401k monies – a so-called “qualified” immediate annuity – the IRS considers your obligation to withdraw RMDs from that money to be satisfied for all years following the year in which you buy your annuity. This is true only with respect to the “premium” or amount you invested in your annuity. You must continue to calculate and withdraw RMDs from the remaining non-annuitized or lump sum IRA monies.

    Your RMDs for money that goes into your annuity in the year in which you buy the annuity must be satisfied with its own calculation. That’s sometimes overlooked. So you should calculate how much RMDs are needed for your pre-annuity lump sum and make sure to cover your total RMDs for that year.

    Some of our clients want to minimize their taxable withdrawals. So if they purchase an immediate annuity using IRA monies early in a year (say, June, as in your example) we’ll help them to set up their annuity start date so they don’t receive income from the annuity until January of the following year.

    Regarding your second question about which funds would be better to invest in your annuity – qualified or non-qualified – that is a more complex topic and my recommendation would be to review your overall financial plans and goals with a fee-only advisor (one who does not market products). The “right” answer to your question will depend on how you are managing all your assets, what your estate tax situation is like, what other sources of income you have, your risk tolerance, etc.

    I’d be happy to speak with you if you have more questions. I can be reached at 800-872-6684. I promise there will be no sales talk. I look forward to speaking with you.

    Hersh

  5. John Homer:
    Jan 22, 2015 at 10:30 AM

    Can a husband's IRA purchase a "life only" SPIA on the life of his wife and have the SPIA income payments be made to the husband during his lifetime (satisfying RMD requirements), and continue to the wife should she outlive him? If not, is there a way to accomplish the same thing?

  6. Hersh Stern:
    Jan 22, 2015 at 10:44 AM

    I'm afraid the answer is no. The only way to accomplish what you've stated is to have your wife be an owner of your IRA. IRAs can only have one owner, and ownership cannot be transferred to another person.

    However, you can still accomplish the outcome you're looking for by purchasing a Joint Life Immediate Annuity. This type of annuity can have two annuitants, but also allows for having only one owner, providing you the ability to purchase it with your IRA. It will pay for as long as either annuitant is living, and will satisfy your RMD requirements.

    -Hersh

  7. David:
    Jan 23, 2015 at 01:04 PM

    I am 70-1/2 years old man and I own a $215k variable annuity that I bought with my 401k money ten years ago. I paid $100k. My question pertains to a RMD. Last year I started withdrawing monthly income from my annuity.

    You wrote in this column that if I start taking money from my annuity then I don’t have to pay minimum required distributions. Is that true in my case?

  8. Hersh Stern:
    Jan 23, 2015 at 01:43 PM

    Hi David,

    In this article I’m only addressing the question of RMDs as it applies to an immediate annuity (a so-called “annuitized” contract) which can no longer be cashed out. This is a critical distinction from other types of annuities that may be surrendered for cash.

    The word “annuitized” refers to a lump sum that is irrevocably converted into a periodic income stream for, say, a lifetime. The operative word is “irrevocably”. When an IRA annuity is annuitized it is considered to have satisfied RMDs. It’s as if the annuity morphs from being a lump sum cash value contract into an immediate annuity.

    But you’re describing a variable annuity contract that has NOT been annuitized so it still is subject to RMDs. In other words, even though your annuity may have been set up for some type of withdrawal phase like LERO or automatic 4% withdrawals or GMIB or GWB, etc., as long as its cash value or cash balance has not been irrevocably turned over to the insurance company under the exercise of the contract’s annuitization clause, it is subject to RMD.

    -Hersh

  9. Les:
    Jan 29, 2015 at 02:25 PM

    I bought an index annuity four years ago when I was 66 years old. Can I receive monthly withdrawals from my annuity to cover RMDs without paying a surrender charge?

  10. Hersh Stern:
    Jan 29, 2015 at 02:40 PM

    Hi Les,

    Nearly all companies permit you to take a penalty-free withdrawal to cover RMDs. Just to be sure, I suggest you call your annuity company or your agent and have them confirm that the payments are without surrender charges and also they can be made monthly.

    -Hersh

  11. Edward:
    Feb 02, 2015 at 02:23 PM

    How is an immediate annuity counted toward the RMD every year and how is the annuity priced on 12/31 each year for next year's RMD?

  12. Hersh Stern:
    Feb 02, 2015 at 02:43 PM

    Hi Edward,

    You won’t need a so-called “fair market value” calculation from the insurance company for an IRA that has been “annuitized” because an immediate annuity has no RMD obligation (see above article) .

    So, generally, insurance companies do not mail FMV letters to owners of IRA immediate annuities. They will, however, send you an FMV letter giving you the value of your annuity if it is not annuitized (e.g., an index annuity or multiyear deferred annuity).

    -Hersh

  13. Ron:
    Mar 26, 2015 at 11:17 AM

    I have a variable annuity and I am approaching 70 1/2 years old. Do I have to apply the RMD rules to this annuity?

  14. Hersh Stern:
    Mar 26, 2015 at 11:19 AM

    Hi Ron-

    RMDs are only taken from an annuity that was funded with pre-tax money. We refer to that annuity as a “qualified” annuity, meaning, the funding source had qualified for favorable tax treatment. So, if you originally rolled over money from an IRA, 403b, or 401k into your variable annuity, then, yes, RMDs need be taken from your annuity each year.

    If your annuity, however, was originally funded with after-tax savings (so-called “non-qualified” money) then no RMD need be taken. The tax code does not require withdrawals ever be taken from a non-qualified annuity even though you may have accumulated untaxed gains through the years.

    -Hersh

  15. Steve:
    Apr 13, 2015 at 09:50 AM

    To avoid any RMD issue what options, other than life only, are best for annuitizing my IRA? Is a joint annuity with my wife OK? Or, is life with installment refund ok to meet RMD requirements?

  16. Hersh Stern:
    Apr 13, 2015 at 09:59 AM

    Hi Steve -

    With either payment option, receiving income jointly with your wife or from a single life annuity with beneficiary payments to your wife (or even other beneficiaries), your immediate annuity will satisfy its RMDs. By that I mean, beginning in the 2nd calendar year, you won’t have to think about RMDs with respect to the money you paid into this annuity. You still will calculate RMDs for any other lump-sums or invested IRA/401k monies you may have, but not for the annuity.

    Separately, in the 1st year, i.e., the year in which you buy your annuity, make sure to take sufficient RMDs for the amount of money that went towards the purchase of the annuity. For example, if you buy your annuity early in the year, say, February or March, then the subsequent monthly payments may generate enough income to satisfy the first year’s RMD for that premium. You’ll need to do the math. If your monthly income doesn’t cover the full RMDs for the premium invested, then you’ll need to make up the difference by taking RMDs from other lump sum IRAs/401k, if you have any.

    Alternatively, if you don’t have any other IRAs/401ks and you are investing all your pre-tax monies in one immediate annuity, then take sufficient RMDs from this money before you buy the annuity.

    -Hersh

  17. Harry:
    Apr 20, 2015 at 09:46 AM

    Do qualified immediate life annuities that have increasing payments come under the same RMD rules for first and subsequent year distributions as level annuities do?

  18. Hersh Stern:
    Apr 20, 2015 at 09:48 AM

    Hi Harry-

    I believe so. For the first year you need to withdraw an RMD amount that would have applied to the full premium (i.e., the amount invested in the annuity) as if you hadn’t purchased the annuity. From the second year on, RMDs are considered “handled” for that money.

    Lastly, since I’m neither a CPA nor a tax attorney I strongly urge you to consult one to confirm my opinion.

    Hersh

  19. frank:
    May 06, 2015 at 11:19 AM

    I rolled over my IRA into an IRA annuity 2 years ago at age 66. I have a 401k also. I plan to work to age 73-74. Can I move my IRA annuity into the 401k plan before age 70 1/2 and avoid the RMD until I retire?

  20. Walter:
    May 08, 2015 at 01:33 PM

    This Sept. my wife will turn 70-1/2 triggering mandatory IRA withdrawals. Could we arrange the RMD 70-1/2 obligation to transfer from the IRA to an immediate annuity purchase?

  21. Hersh Stern:
    May 08, 2015 at 01:34 PM

    Hi Walter--

    You can put the money you take from your IRA into any after-tax account. So, yes, you can buy a so-called non-qualified (or, after-tax) immediate annuity with the RMD money you withdraw from your IRA.

    However, you can’t transfer the amount you are withdrawing from your IRA to satisfy RMDs and transfer it right back into another IRA. Once you remove money from an IRA to satisfy RMDs that money loses its IRA status!

    Hersh

  22. Donald:
    Jun 05, 2015 at 07:45 AM

    If I fund an immediate annuity with money from a non-qualified deferred annuity (by using a 1035 Exchange) then it seems I won't have any RMD'S for those when I'm 70.5 or later?

  23. Hersh Stern:
    Jun 05, 2015 at 07:52 AM

    Hi Donald-

    Yes, you are right. RMDs only apply to pre-tax accounts, monies designated as “qualified,” for example, a traditional IRA, 401k, or 403b. There are no RMDs needed from a Roth IRA or a non-qualified annuity.

    Even if your deferred annuity would have been funded with IRA or qualified money, if you transfer it to a single life or joint life immediate annuity there would be no RMDs required because (as I wrote in the above article) lifetime immediate annuities are considered by the IRS to “automatically” satisfy RMDs.

    You can read more about 1035 exchanges here:

    https://www.immediateannuities.com/1035-annuity-exchanges/

    and IRA and 401k rollovers here:

    https://www.immediateannuities.com/roll-over-ira-or-401k/

    Hersh

  24. Matthew:
    Jun 25, 2015 at 02:54 PM

    I’ve been looking at your SMA page the past few weeks and there’s one listed which begins making payments when I’m 80 years old. Can I buy this SMA with IRA money and do I need to cover RMDs if the annuity has not started to give me income?

  25. Hersh Stern:
    Jun 25, 2015 at 02:56 PM

    Hi Matthew-

    You can buy an SMA with IRA money as long as you establish a “self-directed IRA.” When you purchase an SMA with IRA funds, the income from your SMA is paid back into the IRA account and continues to be tax-deferred. You only owe taxes when you withdraw money from your self-directed IRA.

    Even though the SMA you’re considering delays making payments to you past age 70-1/2 and is not liquid (you can’t invade the principal of an SMA) you are still obligated to fulfill your RMDs for that investment amount at age 70 1/2, just like you must from any Traditional IRA. If this SMA will represent all your IRA holdings and the SMA hasn’t started to generate income, you’ve got a problem. So it’s important to keep some IRA funds liquid to cover the RMD obligation. Don’t invest all your IRA money in an illiquid SMA.

    Hersh

  26. Robert:
    Jan 15, 2016 at 07:21 AM

    I am 66 1/2 years old and considering purchasing a fixed annuity from my TSA account. How will I be affected if I must start withdrawing at 70 1/2? What is your best advice for a person of my age relative to a fixed or other type of annuity?

  27. Hersh Stern:
    Jan 15, 2016 at 07:27 AM

    Hi Robert-

    The right type of annuity will depend on more factors than just the RMD consideration. Since you are unsure about which kind of annuity to select my first piece of “advice” would be to consult a fee-only financial planner and review your retirement goals and financial situation with him or her. Perhaps an annuity is not appropriate for your plans. So best to ask that type of specialist before committing to an annuity.

    Once you are clear about what you want to accomplish with an annuity it become easier narrowing down the type to purchase.

    Now I’ll briefly answer your question about RMDs --

    If you buy an immediate annuity (Single or Joint life, for example) then all RMDs for the premium which went into that annuity are covered by the monthly payments you’ll receive over the life of the annuity. There are no more RMD calculations you’ll need to make with respect to the money you spent on that immediate annuity.

    If you roll your 403b into a Deferred Multiyear or Index (not immediate) annuity you will have an obligation to calculate RMDs on the value of that annuity each year.

    Hersh