Can Annuities Help With Required Minimum Distribution?
A few weeks ago I got a call from someone who I consider to be a mentor in the financial business and I’ve talked about him several times before. By any definition he has been incredibly successful. His main career was as a swaps trader on Wall Street. If anyone has a hard time following my analysis, then don’t even try to understand his career in financial markets because what he did is as technical as things get. He is part of a select class of people because he has an IRA that is of no real use to him but he’s six years away from having to take required minimum distributions. He asked if I thought an annuity would give him an advantage.
He knows plenty about what I do because he analyzes my ideas to see if they make financial sense. It has given me a lot of confidence because I know it means something if he agrees that it’s a good idea. This is what had me thinking about this episode. If I can recommend an annuity to him it will be as objective as possible. No sales job is going to work on this guy because he’s too smart for it. That’s not unlike many of you so I go to extra lengths to cover all contingencies. But this isn’t a case study about my friend because I want to keep this a little more general to apply to others as well.
I see a fair bit of bad advice in relation to required minimum distributions. Investment managers frequently make recommendations with their assets under management as a primary concern. Lots of people are advised to leave IRA assets alone and liquidate other assets first. The IRA balloons and when required distributions come, they are much larger than necessary and push the client into a higher tax bracket than they would have seen otherwise. This happens a lot with Roth conversions when consumers are advised to use cash to pay taxes and let the IRAs grow. It costs more money than it should but the manager got to see his compensation grow.
In most cases you are better off starting a systematic distribution plan as soon as you retire. If you don’t need the money then reinvest it elsewhere in something that has favorable taxation. Any advisor or planner should make this topic a priority but I rarely meet people who have been advised to do it that way. The truth is that most people don’t have to worry about RMDs because they can be dealt with naturally within a good distribution plan for retirement income needs. Others don’t need the RMD for income and might not think an annuity is necessary. In either case, let’s go back to what I said two weeks ago: an annuity will likely make you more money.
First, let’s talk about some rules. If you aren’t taking RMDs already then you’ll probably have to start at age 73. Anyone born later than 1960 gets to wait until age 75. In the first year of RMDs you need to take a little less than 4% of your total IRA balance. If you don’t take it then your penalty is 25% of what you should have taken. People in a really high tax bracket might want to consider that… just joking!
Every custodian that holds one of your IRAs will send you a fair market value letter at the end of every year and that’s the balance you need to use to calculate the required amount. It’s easy because your required withdrawal is stated on the form so you don’t have to do any math unless you pull the withdrawal from one IRA with another IRA, which is allowed so long as you take the combined total of all required withdrawals from every individual account you have. It’s important to realize that excess withdrawals from one IRA can eliminate the need to draw a distribution from a different IRA.
We’re talking about something that is a problem for all retirement distributions, required or not. Sequence of returns will negatively affect growth of a portfolio. An RMD forces you to take money no matter what the market is doing. You could be forced to sell at a loss. Some level of protection is necessary for optimal growth over time.
There are two specific ways that annuities can help with RMDs and don’t forget, either one will just mean you make more money over time. It all depends on whether you need the guaranteed income or not. This is just another way of looking at proper asset allocation that gives you an advantage in retirement. One way to do it is with certain types of income annuities and the other is to use a fixed (MYGA) or fixed indexed annuity to protect a portion of your IRA assets. Just about everyone fits into one of those categories. The only one who doesn’t is someone who doesn’t need the income and doesn’t mind 100% risk in the market. Both annuity strategies will produce more portfolio growth than the guy who avoids the annuity and keeps it all at risk. Let’s look at each one individually.
If your first distribution is 4%, consider that annuity income riders have payouts that start at 8% or better. That means the annuity income will cover the required distribution for twice as many assets. And if the annuity is deferred before income starts, the payout could be even higher. That means you leave market assets alone and they continue to grow. That means you’ll make more money over time. It has to be an annuity with a cash value component to generate the fair market value letter. A single premium immediate annuity won’t work because there is no cash value so the income payment does not offset requirements from other accounts. Now once the cash value of a contract drops to zero then this benefit goes away but you’ll be well into your 80s by that time.
If you don’t need the income then an annuity focused on accumulation is the preferred safe asset for a retirement portfolio and I’ll tell you why. Using a fixed (MYGA) or fixed indexed annuity for the safe asset in your portfolio gives you a stable base of cash to draw a distribution when the market is down in value. You will avoid selling stocks at a loss when the timing is not in your favor. It has to be a contract with 10% free withdrawal allowance so you can pull enough to offset required distributions from other accounts. It will lead to more growth over time and yes, you’ll have more money. CDs and bonds won’t do the same thing. The closest alternative to this that I’ve seen investment managers recommend is to keep a few years worth of distributions in a money market account. That’s fine I suppose if you want the lower yielding cash but don’t forget that they just want to keep more assets under management.
Either of these strategies would work for my friend but I have an easy out. He lives in New York so there aren’t as many annuity options available to him. But for everyone else who doesn’t live in a restrictive state the case can be made that an annuity works whether you need one or not. For many this certainly fits into the category of something you should want. It creates a bigger portfolio, gives you more money to deal with inflation, or provides a larger legacy. Just choose what’s most important to you because there’s absolutely nothing wrong with a little more money.
Have a great weekend!
Bryan
Watch Episode 201: Can Annuities Help With Required Minimum Distribution?
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Last Updated on October 28, 2025 by Bryan Anderson
