Take-Away: While annuitizing a portion of a retirement account can reduce the account owner’s taxable required minimum distribution amount, there are still plenty of unanswered questions that require the IRS’s guidance in hopefully soon Temporary Regulations.

Background: The SECURE Act 2.0 made some changes to an individual’s ability to purchase an annuity in their retirement account. [Section 201 of the Act.] This section removes ‘availability barriers’ to some life annuities purchased using  retirement accounts. Section  201  raises the limit on how much a plan participant can use from their retirement account to purchase a qualified longevity annuity contract (QLAC). In the past the limit was either 25 % of the participant’s account value or $125,000 whichever amount was greater. The new maximum amount is $200,00; this amount is also indexed to inflation. The new rule begins in 2023.

Calculating RMDs: Another rule change [Section 204] deals with ‘liberalizing’ how required minimum distributions (RMDs) are calculated. When a part of a retirement plan account is annuitized, the required minimum distribution (RMD) is calculated differently than the RMD that is calculated for the non-annuitized portion of the retirement account, or an IRA. For the non-annuitized portion of the retirement account, the account owner divides the prior year account balance (on December 31) by the account owner’s life expectancy factor under the IRS Uniform Lifetime Table. For the annuitized portion of the retirement account, the annuity payments the account owner receives during the year are considered the RMD for that year. As a broad generalization, the annual annuity amount received under the QLAC will be larger than the RMD that would be required if the annuitized portion of the retirement account  was determined under the ‘normal’ method that RMDs are calculated, i.e. the prior year account balance divided by the account owner’s life expectancy.

Example: Ed is age 73 in 2023. Ed is therefore required to start taking RMDs in 2023. In 2022, Ed purchased an annuity with $250,000 using his 401(k) account; the annuity is maintained at Insurance Company. That annuity will also pay to Ed a monthly benefit of $1,250 starting in January, 2023. On December 31, 2022 Ed also had another $200,000 held in an IRA that he maintains at GLT Company, invested in mutual funds. Starting in 2023 Ed will receive a total of $15,000 [$1,250 x 12= $15,000] as QLAC annuity payments, which will satisfy Ed’s RMD for the annuity held at the Insurance Company. Under this RMD rule, Ed will also have to take a separate RMD of $7,747.17 from his GLT Company IRA [$200,000 divided by 26.5 ‘factor’ = $7,547.17.] Between these two retirement income sources,’ Ed will be required to take an aggregate of $22,547.17 in 2023.

SECURE Act 2.0: Prior to the SECURE Act 2.0, the account owner could not credit this overage amount against the RMD for the non-annuitized portion of the IRA. Consequently, in the past, the account owner had two separate RMDs: (i) one for the annuitized portion of their retirement account ; and (ii) one for the non-annuitized portion of their IRA. The SECURE Act 2.0 changes this ‘two-RMD’ rule. Beginning in 2023 the IRA owner can receive credit for the fact that the annuitized portion of their retirement assets produces a higher RMD than if that portion was not annuitized. Under this new rule, the account owner combines the value of the annuitized and non-annuitized portions of their retirement accounts  as of the end of the prior calendar year. That amount is then divided by the account owner’s applicable life expectancy factor. That then becomes the account owner’s total RMD for the year. The account owner then subtracts the annual annuity payment from the combined/total  RMD to determine how much of the total RMD remains and that amount must be taken from the non-annuitized portion, i.e. from the IRA.

Example: Same facts as the prior example. The value of Ed’s annuity through his Insurance Company is valued at $250,000 on December 31, 2022. Under the new SECURE Act 2.0 rule, Ed’s total 2023 RMD would be $16,981.12.  [$250,000 (annuity) + $200,000 (IRA) divided by 26.5 ‘factor.’] $15,000 of that total RMD for 2023 will be satisfied by Ed’s 12 monthly annuity payments from the Insurance Company annuity. Therefore, Ed will be required to take only $1,981.13 from his GLT Company IRA. With the change under the SECURE Act 2.0, Ed’s aggregate RMD from the two retirement income sources will be $16,981.13, or $5,566.04 less under the new rule on how to calculate RMDs.

Question: Unfortunately the SECURE Act 2.0 does not provide any guidance on how the QLAC  is valued in order to exploit this new RMD calculation rule. Normally the insurance company is required to report to the annuitant the fair market value of his/her annuity annually on Form 5498. However, once the amount is actually annuitized, that annual report Form is often not furnished to the annuitant, or the end-of-year fair market value of the annuity furnished by the insurance company is not always accurate. Accordingly, there is the need to hear from the IRS, through its Regulations ( we are still waiting for them) , on how to go about valuing the annuity contract each year so that this new rule that is available to  calculate the RMD for the annuity can be comfortably determined.

Conclusion: Using a combined RMD calculation may permit many account owners to hold more in their retirement account without having to take larger RMDs from both their IRA and their QLAC. This permits more flexibility in how much the account owner must take and pay an income  tax on each year. Yet without the necessary guidance from the IRS on how that QLAC is valued for each year few retirement account owners will feel comfortable considering the purchase of a QLAC.