In line with the ideas of some contemporary retirement theorists, SECURE Act 2.0 includes several measures designed to encourage IRA owners to purchase annuities and defined contribution plans to offer annuity options. One obscure but important change is the treatment of annuity contracts in determining required minimum distributions.

Prior to SECURE Act 2.0, annuity contracts held in an account were in a separate RMD universe. If, for instance, an IRA owned an annuity with a value of $250,000 along with $250,000 of other investments, distributions from the annuity after the IRA owner’s required beginning date had to satisfy rules that were almost identical to those for defined benefit plans, and a percentage of the other assets had to be distributed each year. The latter percentage increases as the account owner grows older. At age 72 (currently the earliest age at which distributions are required), each year’s distribution must in most cases be at least 1/27.4th of the account balance as of the end of the preceding year. By age 80, the fraction rises to 1/20.2. At age 90, it is 1/12.2. The IRS table goes only up to age 120, after which the fraction is set at one-half. An immortal with a very large initial balance or incredible investment skill could keep his IRA going forever.

Annuities, by contrast, make level payments, though there is limited scope for cost-of-living or similar increases. Their RMD pattern is thus very different from that of accounts that purchase other sorts of investment.

SECURE Act 2.0 makes it possible to integrate the annuity and nonannuity RMD rules. An account holder may elect to include the value of the annuity in the RMD calculation and count the annuity payments toward satisfying the distribution requirement.

Consider our IRA owner with a $500,000 balance, half in an annuity, half in stocks, bonds, bitcoins or whatever. We’ll assume that the annuity pays him $25,000 a year. Under pre-SECURE Act rules, the required distribution from the rest of the account’s portfolio was a fraction of $250,000. If he was 72 years old, his RMD was $250,000 ÷ 27.4 = $9,124.

SECURE Act 2.0 gives him an alternative. He may choose to add the value of the annuity to the other investments, increasing his numerator to $500,000. His RMD is then $18,248. But his income from the annuity is more than that amount. Therefore, he doesn’t have to liquidate and distribute any of his nonannuity assets.

Eventually, in this case when he reaches age 94 and his distribution fraction 1/9.5, bringing the annuity into the calculation will increase the amount that he has to take from the other assets. At that point, he will probably be able to revert to the pre-SECURE Act 2.0 rules. (The Act appears to allow an annual election, but there’s no way to know whether the IRS will read it that way.) Even if the election is irrevocable, the benefit of additional tax-free accumulation into one’s early 90’s will well outweigh the detriment of somewhat faster distributions later.

This provision was effective on enactment, December 29, 2022. The details will depend on IRS regulations, which aren’t likely to appear soon. In the meantime, taxpayers may rely on a good faith interpretation of the statute.

Reference: SECURE Act 2.0 of 2022, Pub. Law No. 117-328, Div. T, §204.

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