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Playing with Fire? Having an Annuity in Your Traditional IRA

Bigstock-Elder-Couple-With-Bills-3557267Annuities are considered by many to be complex products. Working with IRA required minimum distributions isn’t always an easy trick either. Combine the two, and Kiplinger says, in “RMD Tips: When Your IRA Holds an Annuity,” t it can result in real confusion.

Here are some tips on what you need to know, if you have an annuity in your traditional IRA.

Remember that your required minimum distributions (RMDs) from an IRA must be taken every year beginning in the year when you hit 70½. You can calculate your RMD by dividing the IRA balance as of December 31 of the previous year by a factor based on your age. However, if your IRA holds an annuity, you may have to add its value when figuring your RMD. The type of annuity is important., There are generally three types: immediate, longevity and deferred variable annuities.

The first two types work pretty simply with RMDs. An immediate annuity results in an instant payment stream. It’s typically paid out over the buyer’s life expectancy. This lifetime stream of payments will cover the RMD for the portion of the IRA money invested in it, so that will duplicate the RMD distribution.

Longevity annuities are bought with money now for payouts starting years later (usually age 85). Qualified longevity annuity contracts (“QLACs”) can be purchased with IRA money (up to 25% of retirement account assets or $125,000—whichever is less). Money that is tied up in an IRA QLAC is not counted, when calculating the IRA’s RMD. It’s based solely on any non-annuity holdings.

But owning a deferred variable annuity in an IRA, is where RMDs get a bit hairy. The way you determine the annuity’s value in terms of the RMD, depends on whether it’s been “annuitized.” That means it’s been converted into a stream of payments, usually over the owner’s life expectancy. The rules are different when you annuitize a contract. If the variable annuity is simply an asset in your IRA, its value must be included with the non-annuity holdings when figuring the RMD. Even if you’re withdrawing cash from the annuity, its value on the previous December 31 counts for the RMD. Your insurer may give you an RMD estimate based on the annuity’s value, but that will only cover the annuity. The RMD for any non-annuity IRA holdings must also be calculated, and you can take the total RMD from non-annuity holdings.

Again, when the variable annuity is “annuitized,” the stream of payments will cover the RMD for the IRA value represented by the annuity. Most variable annuities are RMD-friendly, experts say. You’re satisfying the RMD with those payments, and you still have an RMD for the non-annuity holdings.

If you annuitize the contract after you’re subject to RMDs, watch your calculation on the RMD for the first year of payouts. Your RMD in that first year is based on your prior year’s account balance. However, be certain that the total payments you receive during the first year of the annuitized contract are equal to or greater than the calculated RMD. If they’re less, you’ll have to make up the shortfall from non-annuity holdings in your IRA. In later years, the money that’s tied up in the annuitized contract would be excluded from the IRA’s RMD calculation.

Reference: Kiplinger (March 2017) “RMD Tips: When Your IRA Holds an Annuity”

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Avoid This Common Estate Planning Mistake

Will“Most people don’t want to be a burden on their family or children. One of the best things you can do to accomplish this goal, is to get your estate planning in order.”

What if your spouse is ill and you meet with an estate planning attorney to organize your family affairs? The attorney drafts a trust document and a will, and you and your spouse sign it. That’s that. You think everything is fine. However, what if your spouse suddenly dies, and you discover that the accounts aren’t set up to transfer the way you both wanted. Oh-oh. Could this happen to you?

Trust Advisor’s recent article, “These Hidden Estate Planning Mistakes Can Have Horrible Consequences,” reports that it happens all the time.

For instance, a couple might be in their second marriage with no children in common. However, the wife has two children from her first marriage. She and her current husband had been together for 10 years, when she’s diagnosed with cancer.

When they see an attorney, they agreed that her assets would be divided one-third each to the husband and her two children. But most of her assets were in her company 401(k), and the beneficiary on the 401(k) was the husband. No one changed the 401(k) beneficiary designation to reflect the wife’s wishes. When she died, he tried to get the 401(k) to send one-third to each of her children, but it didn’t work. Her employer was legally required to distribute the account, according to the most recent beneficiary designation that they had.

In our example, the husband was a decent sort: he rolled the 401(k) into his own IRA, withdrew the two-thirds for the kids, paid the tax, and gave each of his second wife’s children their share. If they had properly updated the beneficiary form to add the children as direct beneficiaries of the 401(k), the tax cost would have been much less significant. It’s not an uncommon estate planning mistake.

If you have a will and trust, it’s important to note that these account titles and beneficiary designations supersede everything and anything that’s mentioned in your will and trust. If this isn’t set up right, it can mean some time-consuming and expensive maneuvering for your family.

If your accounts list only the husband or wife as the owner, the account titles need to be changed to reflect their trust as the owner. If the wife passes away before this is done, the accounts must go through probate.

Be sure there isn’t a dormant administrative nightmare waiting for your loved ones. Your retirement accounts, life insurance policies and annuities let you designate a beneficiary. Review these periodically and update them if necessary.

Reference: Trust Advisor (March 9, 2017) “These Hidden Estate Planning Mistakes Can Have Horrible Consequences”

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