Required minimum distributions (RMDs) are IRS-mandated withdrawals. Once retirees turn 73, they may need to take preset payments from certain tax-advantaged retirement accounts. RMDs aim to ensure that people eventually pay taxes on funds that have grown tax-deferred.

Whether annuities are subject to RMDs or not depends on the type of annuity and the account in which they're held. Understanding these distinctions is key to avoiding costly penalties and planning for retirement effectively.

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What are required minimum distributions (RMDs)?

RMDs are the minimum amounts you must withdraw annually from tax-deferred retirement plans like traditional IRAs and 401(k)s.

The IRS requires most people to start taking RMDs the year they turn 73. You must take your first RMD by April 1 of the year following the year you reach the applicable age. After that, RMDs are due annually by December 31. But if you’re still working beyond 73, some 401(k), profit-sharing, and 403(b) plans may allow you to delay withdrawals until retirement.

RMDs prevent tax-deferred retirement savings from being untouched indefinitely. They ensure that account holders eventually pay income taxes on the funds that received favorable tax treatment during accumulation.

How are RMDs calculated?

The IRS calculates RMDs by dividing your retirement account balance by your life expectancy factor, as defined by IRS life expectancy tables. The most common is the Uniform Lifetime Table, though there are alternatives for beneficiaries and certain account owners with younger spouses.

Failing to take your RMD on time can trigger a 25% excise tax on the amount you should have withdrawn. If corrected within two years, the IRS may reduce your penalty to 10%.

Do annuities have RMDs?

Variable, indexed, and fixed annuities may be subject to RMDs depending on whether you use pre- or after-tax dollars to fund the account. Let’s explore annuity RMD rules.

Qualified annuities

Typically, you fund qualified annuities with pre-tax dollars and hold them inside retirement accounts like traditional IRAs, 401(k)s, or 403(b)s. Because of the way these plans are structed and defined, the IRS may require withdrawals after age 73. Here’s how much you’ll need to take out:

• If the annuity hasn’t been annuitized (converted to regular income payments), the RMD is typically calculated based on the account value using the IRS life expectancy tables.
• If the annuity has been annuitized, the payments may automatically count towards the RMD requirement, provided the payment schedule meets IRS guidelines. If payments are less than the calculated RMD then you’ll need to withdrawal the difference from other qualified accounts. 

Non-qualified annuities

Non-qualified annuities don’t have RMDs because accounts are funded with after-tax money — the IRS has already taxed your contributions. Earnings within the contract grow tax-deferred, and you’ll only pay taxes on the earnings portion of withdrawals. There’s no penalty for leaving funds in the annuity as you age.

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Do annuity payments count toward RMDs?

Converting your qualified annuity into a stream of regular income payments typically counts towards your RMD for that contract. The SECURE 2.0 Act also introduced a little-known change that allows excess annuity payments to cover RMDs for other qualified accounts.

Say you use your 401(k) funds to invest in a qualified annuity. When you turn 73, you may need to take RMDs for both the annuity and the 401(k) as a whole to satisfy the RMD requirements. In this example, you annuitize and start receiving $1,000 a month from the qualified account. Your RMDs for the annuity are only $500, so the remaining $500 can count towards the 401(k)’s RMD payments.

This can be a huge advantage because it can leave more funds invested within your 401(k) while still fulfilling your RMDs.

However, keep these key points in mind:

• Account type: The extra annuity funds only count toward the qualified retirement account they’re held in.
• Payment amount: If the annuity payout is too small, it may not fully satisfy your distribution for the year. You'll need to ensure your total distributions meet the overall RMD requirement, even if one annuity covers only part of it.

Bottom line: If you're receiving regular income from a qualified annuity, those payments may fully or partially fulfill your RMD if they align with IRS rules. Confirming with a tax professional or financial advisor is a good idea to make sure you're withdrawing enough to avoid penalties.

How to calculate your annuity RMD

Calculating an annuity RMD involves a few simple steps:

• Determine your annuity’s year-end account value: Look up the contract value of your annuity as of December 31 of the previous year. This number is the basis for calculating RMD.
• Find your IRS life expectancy factor: Check the IRS’s Uniform Lifetime Table (or Joint Life Table if applicable). Find the factor corresponding to your age on your birthday during the current calendar year.
• Use the following formula: Contract Value ÷ Life Expectancy Factor = RMD.

Say you’re 80, your contract is worth $500,000, and your IRS life expectancy factor is 20.2. Your RMD would be: 

$500,000 ÷ 20.2 = $24,752

Understanding annuity types as part of your retirement plan

Knowing RMD rules is an essential part of retirement income planning, especially when annuities are part of your portfolio. At Gainbridge, we offer flexible annuity plans with no hidden fees or commissions so you can plan for retirement confidently. 

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Whether you're exploring annuities for guaranteed income in retirement or planning how to take care of your family after you're gone, Gainbridge has a solution for you. 

‍This article is intended for informational purposes only. It is not intended to provide, and should not be interpreted as, individualized investment, legal, or tax advice. For advice concerning your own situation please contact the appropriate professional. The GainbridgeⓇ digital platform provides informational and educational resources intended only for self-directed purposes.