Proposed Changes to IRS RMD Rules Regarding Annuitization

Recent IRS proposals clarify required minimum distribution (RMD) rules for annuities in retirement accounts. Following the SECURE Act and SECURE 2.0, these changes simplify the valuation of annuities and their aggregation with other account balances.

Over the last several years, there have been sweeping changes made in regard to the rules surrounding retirement plans. Both the SECURE Act of 2019 and SECURE 2.0, which was passed in 2022, have implications that affect distributions from workplace plans and IRAs. 

Many of these rules focused on required minimum distributions (RMDs). Some changed the age at which a retiree must begin taking them, while others affected the manner in which they are calculated, or whether and how they applied to beneficiaries. After they were rolled out and became effective it became clear that some of the details contained in them were ambiguous. This left many people, including professionals, unsure of how they were supposed to apply them.  

To address this, the IRS issued final regulations in July 2024 to clarify certain changes, while also proposing additional adjustments.

In this article, we will go over a newly proposed regulation that will impact RMDs from annuities held within retirement plans.

Calculating RMDs

While the proposed regulation itself is fairly straightforward, we need to establish some background to put it in the right context. To start, let’s take a look at how buying an annuity within a retirement account could affect RMD calculations.

RMDs follow a precise calculation method. They are based on the balance of the retirement account and the account owner’s life expectancy. In simple terms, they are meant to force the withdrawal of the entire balance evenly over the owner’s remaining life. 

Let’s illustrate with an example: Suppose someone has an account balance of $500,000 and a life expectancy of 25 years. To calculate the RMD, you would divide the $500,000 by 25, which equals $20,000. Therefore, the individual would be required to withdraw at least $20,000 for that year.

It’s important to remember that the RMD must be recalculated annually to account for changes in both the account balance and the individual’s life expectancy.

SECURE Act 2.0 Impacts

In the past, purchasing annuities within a tax-deferred retirement account could pose some potential problems when it came time to begin RMDs.

Before SECURE Act 2.0

Before the SECURE Act 2.0 was passed, if only a portion of the account balance were used to buy an annuity that amount was set aside. It was effectively treated as a separate balance within the account. Annuity payments could satisfy the RMD requirement for the annuity, while the rest of the account balance was subject to the RMD calculation on its own.

For example, suppose you have $500,000 in an IRA and a life expectancy of 25 years. If you use $250,000 to purchase an annuity that pays you $15,000 per year, the remaining $250,000 stays invested in various funds. As mentioned earlier, your total RMD for the $500,000 would be $20,000. Since half of the balance is now in an annuity, you only need to calculate the RMD on the remaining $250,000. That means your RMD on the non-annuity portion would be $10,000.

On the one hand, this simplifies the RMD calculation for the annuity portion, since it is excluded from the total. On the other hand, it could result in a larger-than-necessary withdrawal. Even if the annuity payments exceed the RMD for that portion, you would still be required to calculate and withdraw an RMD for the remaining balance.

After SECURE Act 2.0

The SECURE Act 2.0 provided a way around that. Rather than treating annuity and non-annuity balances separately for RMDs, an account holder may elect to treat the entire balance as one. This would allow annuity payments to count toward the total RMD requirements for the remaining balance as well. 

Let’s revisit our example: Your total required withdrawal would be $25,000. Of that, $15,000 comes from the annuity, but you would still need to take a $10,000 RMD from the remaining balance of your $250,000 non-annuity funds. However, since your $250,000 annuity pays $15,000 per year—$5,000 more than the RMD on that portion—you can now apply that extra $5,000 toward your overall RMD requirement, thanks to the SECURE Act 2.0. This means you no longer lose the extra $5,000 as you would have before.

In total, your account balance—including the annuity—remains $500,000, which requires a $20,000 RMD. Since your annuity already pays $15,000, you would only need to withdraw an additional $5,000 from your $250,000 non-annuity balance to meet your total RMD requirement.

New Proposed Regulation

Now that you have that background information, the proposed regulation is fairly simple. 

Recall that RMDs are recalculated each year to reflect updated account balances. In the regulations that were finalized in 2024, a placeholder was reserved for specifying exactly how annuities should be valued each year when aggregating them with non-annuity balances as described above and provided for in the SECURE Act 2.0. The proposed regulation fills in that gap. Specifically, this proposed regulation:

• Stipulates that the fair market value of the annuity should be taken as of December 31 in the prior year. This is the same treatment that applies to IRAs and qualified plans like 401ks.
• Provides that beginning with the 2026 distribution, the fair market value must be made using the method as described in § 1.408A-4, Q&A-14(b)(2). This is called the “gift tax method”. It sets the fair market value of the annuity as the current price at which you would be able to buy a comparable annuity with a similar contract. If there is no comparable annuity currently available then the value may be derived from the policy’s terminal reserve value.

Annuity issuers are required to provide these valuations.

The recent IRS proposals aim to clarify and simplify the RMD rules for annuities within retirement accounts, particularly following the changes introduced by the SECURE Act and SECURE 2.0. By establishing a clear method for valuing annuities at year-end, the proposed regulation allows for better integration of annuity payments into RMD calculations. This approach not only simplifies compliance but also ensures that retirees can more effectively manage their withdrawals, leveraging the value of their annuities to meet overall RMD requirements.

Editor Norah Layne contributed to this article.