Turning your individual retirement account into a stream of guaranteed retirement income poses challenges under the minimum distribution rules. The Internal Revenue Service is working to minimize those challenges (most recently by blessing longevity annuities) within the confines of Internal Revenue Code Section 401(a)(9).

Annuity vs. MRD 

Frank, age 70, wants to convert his $1 million IRA1 (currently invested in mutual funds) into a lifelong stream of guaranteed income payments. In short, he wants to annuitize his IRA.2 An insurance company has agreed to take Frank’s $1 million and, in exchange, promises to pay him $6,600 a month for the rest of his life. Following the trade, his IRA’s only asset will be this single-life annuity contract.

Frank is ready to sign on for this deal (retirement income has long been his goal for this IRA), but he never makes a move without checking with his tax advisor (you). He asks you: “I know I’m required to take a minimum required distribution (MRD) every year from my IRA, starting the year I reach age 70½. How do I compute my MRDs once the investment fund has been converted to an annuity contract?”

If you tell Frank that he should, each year, take the prior year-end value of his IRA and divide it by the factor for his age from the IRS’ Uniform Lifetime Table,3 you’ll be wrong. Yes, that’s usually the right way to compute MRDs for an IRA—but only if the account hasn’t been annuitized. This familiar method doesn’t work once an IRA has been converted into an annuity contract. For one thing, there’s no longer any account balance to be valued; the IRA’s only asset is a promise from the insurance company. Even if you can put a value on that promise, Frank still can’t take MRDs the traditional way, because he has no right to take more or less than the annuity payments the insurance company owes him under the contract—regardless of what the usual MRD formula might say he must withdraw.

That’s why the IRS issued a completely different set of minimum distribution rules for annuitized defined contribution plans.4 The approach of these separate rules differs radically from that of the defined contribution plan rules that typically apply to IRAs. Instead of annually dividing the account balance by a life expectancy factor to produce the required distribution amount, the rules simply dictate what types of annuity contracts may be purchased inside a defined contribution plan. After a permitted contract is purchased, the participant has no obligation to take any distributions from the account at all. Rather, all payments made under that contract are considered required distributions. 

Annuity Options

The point of the rules is to make sure that annuity payouts aren’t used to unduly prolong the distribution of the benefits—that is, the purpose of the minimum distribution rules—while still allowing participants as many choices as possible for using annuity contracts to provide retirement income through their qualified plans and IRAs.5 

Here’s a summary of what the rules dictate regarding an immediate annuity purchased inside an IRA.6 Payments under the contract must:

1. Begin no later than the participant’s required beginning date;7

2. Be made at least annually; and

3. Be non-increasing (that is, they can’t increase over time). 

There are exceptions to the non-increasing rule: Cost-of-living increases and certain similar increases are permitted. The contract may allow for an increase (pop up) of benefits upon certain events, such as divorce or the death of the beneficiary prior to the participant’s death.8 Also, an annuity contract purchased from an insurance company may provide for cashout of the contract and various other features that an annuity paid directly from a retirement plan may not.9

The most important limitation is the period of time over which the annuity payments must be made. The annuity contract must be for:10

1. The life of the participant, with no minimum guaranteed term;

2. The joint lives of the participant and his spouse, terminating at the death of the surviving spouse, with no minimum guaranteed term. The payments to the spouse can be the same as the payments to the participant or any lesser amount;

3. The joint lives of the participant and his non-spouse beneficiary, terminating when both of them are deceased, with no minimum guaranteed term. If the non-spouse beneficiary is more than 10 years younger than the participant, the payment to the beneficiary can’t exceed a certain percentage of what the participant was receiving. The percentage depends on the age difference between the participant and the beneficiary;

4. A period certain, with no life component. The period certain may not extend beyond, approximately, the participant’s late 90s or the joint life expectancy of the participant and spouse in certain cases; or

5. The participant’s life, or provide a joint and survivor annuity for the lives of himself and his beneficiary, with a minimum guaranteed term. However, the minimum guaranteed term can’t extend beyond approximately the participant’s late 90s. This menu gives Frank many options for annuitizing his IRA. He can buy the straight single-life annuity he’s been looking at. Or, he could dress that up with cost-of-living increases, a minimum guaranteed term and/or survivor benefits for his wife or other beneficiaries. He can buy any of these features that an insurance company is willing to sell him. Of course, each added feature will reduce the monthly payment Frank receives. What can’t he do? He can’t structure an annuity contract that would violate the purpose of the minimum distribution rules, which is to assure that most of the money in his IRA will be distributed to him during his lifetime, if he lives to a normal life expectancy. So, he can’t buy an annuity with a guaranteed term of 1,000 years. He can’t buy a joint and survivor life annuity with his one-year-old grandchild that will pay $1,000 a month first to Frank for his life and then to the grandchild for her life.

Practitioner Traps

Presumably there’s little danger that an IRA owner would purchase from an insurance company an annuity contract that doesn’t comply with these rules. Hopefully, the companies that issue the contracts are familiar with the rules and don’t sell non-complying contracts to IRAs. The traps catch practitioners who, because they don’t understand the rules, advise clients incorrectly regarding the effects of purchasing an annuity contract inside an IRA. I’ve seen two types of practitioner mistakes in this area:

Mistake 1: Rolling over annuity payments. The first hazard lies in the rule that all payments under the annuity contract are MRDs.11 An MRD can’t be rolled over to another retirement plan; it’s not an eligible rollover distribution.12 This trap snares practitioners who tell their clients to annuitize an IRA for creditor protection or Medicaid planning purposes, then tell their clients to roll over payments made under the contract to another IRA to defer taxation. It can’t be done.13 You can’t evade this problem by having the annuity contract payments made directly to another IRA, because transfers from one IRA to another aren’t treated as “distributions” for any purpose and, thus, don’t fulfill the minimum distribution requirement.14

Mistake 2: Counting annuity payments towards MRDs for other assets. If only part of the IRA is annuitized, the IRS treats the annuity contract and the non-annuitized portion of the account as two separate accounts.15 Thus, the distributions under the annuity contract are treated as required distributions with respect to the contract, but (except in the year the contract is purchased) they don’t count towards the distribution requirement applicable to the non-annuitized portion of the IRA.16 The non-annuitized portion must continue to pay required distributions too, based on the value of the non-annuitized assets.  If your client uses part of his IRA to purchase an annuity, remind him that the annuity payments can’t be rolled over and that he must continue to take annual MRDs with respect to the non-annuitized portion of the IRA.

Longevity Annuities

One more thing Frank can’t do: He can’t buy a “longevity annuity” in his IRA. 

Many retirees worry about running out of money. One solution is to hoard money (spend less) today because they might live well beyond the average life expectancy. The problem with that solution is that it causes everyone to live below his possible standard of living, even though not everyone will live long enough to have a problem. The insurance industry’s solution: For a lump sum payment that’s relatively small while your client is only in his 50s or 60s, your client can buy an annuity now that doesn’t start paying out until he reaches his mid 80s. Such a longevity annuity enables your client to spend more during his “young old years” without worrying that he’ll run out of money if he lives too long. But, that type of annuity can’t, today, be purchased inside an IRA, because of the rule that payments under an IRA-owned annuity contract must begin by the required beginning date.

The IRS is riding to the rescue. Under recently issued proposed regulations, up to 25 percent of the participant’s account balance (but not more than $100,000) can be invested in a qualified longevity annuity contract (QLAC) without violating the minimum distribution rules.17 A QLAC must generally: (1) begin paying out when the participant reaches age 85; (2) provide no death benefit other than a life annuity to the surviving beneficiary; and (3) not be a variable or equity-indexed contract. Watch for brisk sales of QLACs to IRAs once the regulations are finalized.

Other Plans and Products

Roth IRAs aren’t subject to the restrictions dictating what annuity provisions may apply during a participant’s life, because the minimum distribution rules don’t apply to a Roth IRA until after the participant’s death. Thus, a Roth IRA owner can buy a longevity annuity in his account right now, without waiting for the regulations to be amended and without being subject to the percentage/dollar limit and other specifications applicable to QLACs.18 

The rules dictating what an annuity must and may not provide also don’t apply to a deferred variable annuity (a popular type of IRA investment), unless the contract is annuitized. Until then, the deferred variable annuity is subject to the regular defined contribution plan minimum distribution rules, though they’re also subject to a special valuation rule.19

Finally, though the minimum distribution rules assume that the world is divided neatly into annuities and non-annuity contracts, the insurance industry (in response to market demand) is busy developing more and more hybrid products: Contracts that provide guaranteed life income (like an immediate annuity), while preserving investment upside potential and capital access (like a non-annuity). The hybrids will challenge the IRS, plan administrators and practitioners, as they try to figure out which set of rules governs each product. As the baby boom generation moves into its retirement years, Jane Austen might predict that the future looks bright for annuities inside IRAs, because “A large income is the best recipe for happiness I ever heard of,”20 and “People always live for ever when there is an annuity to be paid them.”21


1. See Internal Revenue Code Section 408. Unless otherwise specified, the discussion in this article pertains only to traditional (non-Roth) individual retirement accounts. 

2. The word “annuitize” isn’t in the dictionary. The Internal Revenue Service and I use it to mean the conversion of an investment fund or sum of cash into an annuity. See, e.g., Revenue Ruling 2002-62, 2002-42 I.R.B. 710, and Treasury Regulations Section 1.401(a)(9)-6, A-12(a), (d) (Example 1), A-13(b), (c), A-14(c). An annuity is a stream of periodic payments that the payer promises to pay for a specified term of years or for one or more lifetimes; this is also sometimes called an “immediate annuity.” The key element of annuitization is that the annuitant is relieved of the risk that his fund will run out of money prior to expiration of the specified term (or lifetime). In exchange for that assurance, he gives up his capital and the potential for any profits beyond the guaranteed payments. See Treas. Regs. Section 1.72-1(a). 

3. Treas. Regs. Section 1.401(a)(9)-9, A-2. For an explanation of the minimum distribution rules applicable to non-annuitized IRAs and other defined contribution (individual account) plans, see Chapter 1 of my book, Life and Death Planning for Retirement Benefits (7th ed. 2011), Ataxplan Publications, www.ataxplan.com. 

4. See Treas. Regs. Section 1.401(a)(9)-6, issued in 2004. The more familiar minimum distribution rules for non-annuitized defined contribution plans were issued in 2002. The 2004 regulation applies to defined benefit plans and to annuities purchased within defined contribution plans (also called “individual account plans”) such as IRAs. Since this is a journal for estate-planning professionals, not retirement plan administrators, the article will discuss only annuities purchased within IRAs. 

5. See Treasury Decision Preamble T.D. 9130, 69 FR 33288, June 15, 2004. 

6. The summary in this article comes from Treas. Regs. Section 1.401(a)(9)-6, A-1(a), unless otherwise indicated. For a complete explanation of the regulation, see my “Special Report: When Insurance Products Meet Retirement Plans,” www.ataxplan.com. 

7. Treas. Regs. Section 1.401(a)(9)-6, A-1(c)(7). For an IRA, that date is April 1 of the year following the year in which the participant reaches age 70 1⁄2. IRC Sections 408(a)(6), 401(a)(9)(C)(i)(I), (ii)(II). See par. 1.4.02 of Life and Death Planning for Retirement Benefits, supra note 3. 

8. Treas. Regs. Section 1.401(a)(9)-6, A-14. 

9. Ibid. 

10. See Treas. Regs. Section 1.401(a)(9)-6, A-1(a), A-2(a)–(d) and A-3(a). 

11. Treas. Regs. Section 1.401(a)(9)-5, A-1(e). 

12. IRC Section 408(d)(3)(E). For discussion of the rule that a minimum required distribution (MRD) can’t be rolled over, see par. 2.6.03 of Life and Death Planning for Retirement Benefits supra note 3. 

13. For the effect of rolling over an MRD in violation of this rule, see my “Special Report: IRAs With Hair,” www.ataxplan.com. 

14. Rev. Rul 78-406, 1978-2 C.B. 157. See also Instructions for IRS Forms 1099-R and 5498. 

15. Treas. Regs. Sections 1.401(a)(9)-8, A-2(a)(3), 1.408-8, A-1(a). 

16. Treas. Regs. Section 1.401(a)(9)-5, A-1(e). 

17. See  Proposed Treas. Regs. Sections 1.401(a)(9)-5, A-3, 1.401(a)(9)-6, A-12, Q&A-17,
1.403(b)-6, 1.408-8, 1.408A-6, and 1.6047-2, in IRS “Notice of Proposed Rulemaking: Longevity Annuity Contracts,” REG-115809-11, I.R.B. 2012-13
(March 26, 2012), at pp. 598–611. 

18. Prop. Treas. Regs. Section 1.408A-6, A-14.  19. Treas. Regs. Section 1.401(a)(9)-6, A-12(a).  20. Jane Austen, Mansfield Park.