Q. I just heard about a new IRS rule that gives favored treatment to the purchase of an annuity inside an IRA. Do you know anything about that?
A. Yes. You refer to the new IRS rule that allows an owner of a Traditional IRA to use a portion of his or her IRA or 401K funds to purchase a longevity annuity without the need to comply with the Required Minimum Distribution (RMD) rules. This is great news for owners of Traditional IRA’s.
Background: previously, the RMD rules required that an annuity purchased inside a Traditional IRA or 401K had to start distributions when the owner turned 70.5, even if the owner did not need the money at that time. There was no real option to defer the annuity start date, so as to allow the annuity to grow in value inside the IRA and begin larger payouts at a later date. In short, the RMD rules previously clashed with the goal of planning for lifetime income. Thus, for those who wanted to defer the annuity start date, often the only option was to purchase an annuity outside the Traditional IRA with after-tax dollars, or use after-tax dollars inside a ROTH IRA.
The new rule now gives owners of Traditional IRA’s the green light to put a portion of their portfolio into a longevity annuity to provide for guaranteed income beginning at a future date, which can begin as late as age 85. By permitting this deferred start date, the rule allows for the interim growth of the annuity contract, and hence higher payouts beginning at a future date. The longer pay outs are deferred, the more money the owner receives. In short, the rule allows retirees to insure themselves against the risk of outliving their money, because they can provide lifetime income for themselves starting later in life.
There are some requirements, including the following: (1) Only up to 25% of the IRA account value, capped at $125,000, can be used to purchase a Qualifying Longevity Annuity Contract (“QLAC”); (2) the annuity must begin payout by age 85; and (3) the annuity must be irrevocable once purchased. The rule also permits the contract to have a “return of premium” feature: if the IRA owner dies before receiving back all of the annuity premium payment, the difference will be paid back to his or her beneficiary. Also, the $125,000 cap will be subject to cost of living adjustments. Retirees who choose to take advantage of this new option can still invest the remaining 75% of their IRA or 401(k) account balance in other assets, as before, with the understanding that only these assets will be used to calculate the RMD’s with the mandatory start date at age 70.5.
This new rule is especially significant for those persons who are not yet ready to retire or who do not need to begin drawing on their Traditional IRA or 401K at age 70.5. It is worth a serious look.
For more, see IRS Notice 2014-66, IRS Press Release and Regulations