Buying an Immediate Annuity in a Traditional IRA

[umfundi]

All,

I found the discussion in this thread simply too complicated:

viewtopic.php?f=10&t=106832

So, my question is: Suppose I have $500,000 in a traditional IRA. It is invested in only one fund, Vanguard LifeStrategy Moderate Gr Inv: VSMGX.

I am contemplating taking some of those savings to buy a Single Premium Immediate Annuity (SPIA) that yields 7%. I am interested in assured income for life. Let's assume I take half, $250,000, to generate $17,500 of yearly income.

Can I buy the SPIA inside the IRA and put the SPIA "income" back in the IRA with no tax consequences? Then, can I withdraw from the IRA as I need it (or to meet RMD) and pay tax only on the withdrawals?

Is this even a viable option to think about?

By the way, I am interested only in the mechanics, legality, and tax consequences, not in the behavioral aspects of SPIAS.

Keith

PS: Even asking the question makes my head hurt. I can't imagine what the answers will be.

[JDCPAEsq]

Simple answer: No. Once you buy the SPIA taxable payments will be made to you, not to the IRA
John

[Levett]

Keith,

I'm in no way questioning John (I actually own an IRA that can be annuitized, but I've chosen not to do so).

However, it appears that versions of your question have appeared at Ed Slott's discussion site, so here's a link in the hopes that the exchanges may touch on some of your interests.

http://www.irahelp.com/forum-post/14750-annuitized-ira-annuity-rmds

Lev

[sscritic]

I believe you can. The problem comes when it is time for your RMD. The insurance company has to place a value on the remaining annuity payment stream so you can figure out the value of your IRA as of 12/31 so you know what your RMD is. That is why most people use IRA money to buy an SPIA that pays directly to you; that SPIA meets the RMD rules for the value of the annuity so you can leave it out of your calculations.

When you use part of your Individual Retirement Account to purchase a SPIA, the SPIA is part of the Individual Retirement Account and you must calculate your RMD by including the value of the SPIA. This can be tricky as the value of the SPIA may not be easily determinable every year. Because an RMD is based on the value of the funds in the Individual Retirement Account at the end of the prior year (i.e. a 2011 RMD is based on the value of your Individual Retirement Account as of 12/31/10) you must include in this value calculation the value of the SPIA. How is this done? You must determine the present value of the SPIA at the end of the prior year so that the value of the Individual Retirement Account can be determined in order to then determine the RMD.

Most people buy an SPIA as an Individual Retirement Annuity which makes payments to you that are taxable as withdrawals (it is a trustee to trustee transfer,* from an IRAccount trustee to an IRAnnuity trustee)

A transfer of funds in your traditional IRA from one trustee directly to another, either at your request or at the trustee’s request, is not a rollover.

.

Remember that IRArrangements come in those two forms: Accounts and Annuities.

This publication discusses individual retirement arrangements (IRAs)
...
Your traditional IRA can be an individual retirement account or annuity.

pub 590

* I could be wrong about this, as I am about many things.

[brick-house]

My understanding is that any payment stream over ten years cannot be rolled over or deposited back into the account.

Quote from IRS Publication 575

http://www.irs.gov/publications/p575/ar ... 1000226891

Eligible rollover distribution. An eligible rollover distribution is any distribution of all or any part of the balance to your credit in a qualified retirement plan except:
1.Any of a series of substantially equal distributions paid at least once a year over:

a.Your lifetime or life expectancy,

b.The joint lives or life expectancies of you and your beneficiary, or

c.A period of 10 years or more,

2.A required minimum distribution (discussed later under Tax on Excess Accumulation ),

3.Hardship distributions,

4.Corrective distributions of excess contributions or excess deferrals, and any income allocable to these distributions, or of excess annual additions and any allocable gains (see Corrective distributions of excess plan contributions , at the beginning of Taxation of Nonperiodic Payments, earlier),

5.A loan treated as a distribution because it does not satisfy certain requirements either when made or later (such as upon default), unless the participant's accrued benefits are reduced (offset) to repay the loan (see Loans Treated as Distributions , earlier),

6.Dividends paid on employer securities, and

7.The cost of life insurance coverage.


In addition, a distribution to the plan participant's beneficiary generally is not treated as an eligible rollover distribution. However, see Qualified domestic relations order (QDRO) , Rollover by surviving spouse , and Rollovers by nonspouse beneficiary , later.

[FinancialDave]

Simple answer: No. Once you buy the SPIA taxable payments will be made to you, not to the IRA
John

I believe this is correct, in that once the annuity is annuitized it becomes its own separate account so to speak and the checks come to you directly and tax is paid. In other words it is no longer a part of any RMD calculations.

I believe the gray area arises in the discussion on the website listed above if you annuitize during a year where RMD's are already due, which I don't think was part of your question. In that case I believe the only question is how you calculate the RMD in the one year that you annuitize, after that there is no question.

fd

[umfundi]

Keith,

I'm in no way questioning John (I actually own an IRA that can be annuitized, but I've chosen not to do so).

However, it appears that versions of your question have appeared at Ed Slott's discussion site, so here's a link in the hopes that the exchanges may touch on some of your interests.

http://www.irahelp.com/forum-post/14750-annuitized-ira-annuity-rmds

Lev

Lev,

Thank you. I will check it out.

Keith

[brick-house]

Annuity payments count as its own RMD. The remaining balance would then have to have a separate RMD taken.

Simple example. Fair warning -I am not a CPA, just another crank on the internet...

12-31-2011 IRA balance is $200,000. On Jan 3, 2012 -100,000 is annuitized - annuity payments are considered toward RMD for 2012 because RMD is based on 12-31-2011 balance of $200,000. However, that all changes on 12-31-2012. On 12-31-2012-the balance of the IRA is less the annuity balance. The annuity commuted value is not listed as part of your 12-31-2012 balance. So, for years 2013 onward - this individual would receive annuity payments; plus need to take an RMD on the remaining IRA balance.

http://www.morningstar.com/cover/videoC ... ?id=336278

[Levett]

brick-house described himself as "just another crank on the internet..."

Not a chance!

Lev

[Alan S.]

If you pruchase an annuity in an IRA, it should be in an IRA annuity account, not in a standard custodian IRA agreement.

A non annuitized IRA annuity has the same basic RMD rules as any other IRA account since there is always an year end balance for these IRA annuities. However, the IRS has established rules under which the value of fringe benefits that exceed IRS thresholds is added to the account balance for RMD calculation. This is very complex, so you need to get this amount from the insuror, who must provide it. These IRA annuity RMDs can be aggregated with other non annuity IRA accounts as they all have year end values.

Annuitization is when things get more complex. Prior posters are correct that in the year after the IRA is annuitized, the IRA annuity distribution IS the RMD for that part and the other IRAs with account balances have RMDs calculated in the usual manner. At this point there is no aggregation between the IRA annuity and the standard IRA.

The IRS Regs for RMDs on defined benefit plans and annuities are contained in 1.401(a)(9)-6, and this Reg was written mostly for DB plans and is mostly concerned with period certain annuities that extend life expectancy too long and defer taxes longer than the IRS desires. There is NO mention of period certain IRA annuities for much shorter periods than life expectancy, however it appears the IRS considers any annuitization of an IRA to result in an RMD. This is important because if you annuitize for a 10 year period certain at age 70, the distribution will be much larger than a typical RMD. But since the distribution IS deemed to be the RMD, there is no amount of that distribution that can be rolled over. The key to any thought of doing an IRA rollover starts with determining how much of a distribution is actually the RMD.

I suppose you could purchase an IRA 5 year SPIA at age 63 for purposes of investment return and roll over the proceeds, but you would have to limit distributions to one per year because you cannot do more than one rollover per year per IRA account. Or a direct transfer could be set up between the IRA annuity and another of your IRAs. But once you reach the year you turn 70.5 and RMDs kick in, the rollovers are no longer allowed.

In theory, the insuror could calculate a present value of the annuity cash flow and use it as a surrogate for a year end value. But there is no indication anywhere that the IRS would approve that approach. Some insurors may have done it in the past, but IRS RMD oversight has been so poor that they may not have heard from the IRS. A 5498 showing a year end value is not likely to be questioned by the IRS and they have no other way of knowing annuitization has occurred.

The IRS is starting an IRA rules initiative to close the gaps on such things as RMDs and excess contributions. It would be a tax revenue raiser compared to prior lax oversight. It would probably start with some warnings in Pubs and to custodians and tax preparers, and in fact many tax firms are already beefing up IRA training as a result of the IRA announcing this initiative.