With all of the tools available for planning for retirement, sometimes it’s hard to tell what’s what. For some, the retirement toolkit includes annuities and individual retirement accounts (IRAs). But the question arises: is an annuity an IRA, or are they separate tools? And does it even make sense to combine them?
Is an Annuity an IRA?
The short answer is no. An annuity is an annuity, and an IRA is an IRA. But to be more specific, you might say that sometimes an annuity is used within an IRA, in which case you have an IRA annuity.
To use an analogy, think about beaches and resorts. Beaches are like annuities, and resorts are like IRA accounts. In some resorts, you’ll find a beach. And sometimes when you’re at a beach, you’ll also be at a resort. But you can use each of them separately: it’s possible to visit a resort without a beach (a ski resort, for example) and you can also find beaches that are not part of any resort.
So let’s bring this back to the world of retirement planning. An IRA is simply an account with certain tax features. You can use many different types of investments within an IRA, including annuities (but you can also use stocks, mutual funds, cash, and other types of investments). Along those same lines, an annuity is just a type of investment issued by an insurance company. It can be used in an IRA (or other type of retirement account), or it can be used on its own.
Should You Use an Annuity in an IRA?
The question for retirement savers is whether or not to use annuities in IRAs. In some situations it makes sense, while in other situations there’s just no point.
Any time you’re considering an annuity, you have to evaluate what you get from the insurance company. Annuities only make sense if the guarantees provided are worth whatever you’re giving up: extra money you pay in fees, a loss of control over the funds, potential tax issues, locking your money up, and so on.
So let’s apply that to the question of annuities and retirement accounts (including IRAs, 401(k)s, and lump-sum pension payments). How might it make sense to use an annuity as an IRA?
Immediate annuities can be purchased with money from a retirement account. You roll your money over into the annuity, and the insurance company starts making payments to you. This can make sense if you want a guaranteed stream of income from the insurance company. Those payments might come to you for the rest of your life or for a set number of years. But using this kind of annuity in an IRA means that you lose control of all of your retirement savings. If you want money back faster than the insurance company is going to pay you, you’re out of luck.
Deferred annuities can also be funded with money from retirement accounts. But instead of taking your payments immediately, you just leave the money in the annuity – you might start taking payments someday, or you might not. Deferred annuities might offer guarantees related to protecting or growing your retirement savings, or that allow you to take a certain level of income out of them. But those guarantees come at a cost, so you need to evaluate the trade-offs.
Red Flags
When does it make less sense to put an annuity in an IRA? When there’s no good reason to do so. Sometimes annuities are sold as tax-deferred investments, but you don’t benefit from the tax deferral when your money is already in a retirement account – you can roll it over to another retirement account without tax consequences anyway. Putting IRA money in an annuity is like wearing a belt and suspenders at the same time. You need an additional reason besides tax deferral.
Another thing to consider is your health. Of course, there’s no way to know what will happen as you age, but you should proceed with caution if you know that you have especially poor health. Immediate annuities might not pay off if you don’t live long enough, and they make it difficult (or impossible) to get cash if you have major medical expenses. You might find somebody out there who will pay you a lump sum in return for your future annuity income, but those deals are risky.
Finally, beware of salespeople pushing you to put all of your money into an annuity. Those products pay hefty commissions, and unfortunately they can tempt insurance agents to put their interests first. An annuity might be a useful tool as you plan for retirement, but it’s unlikely that 100% of your IRA needs to go into an annuity.
How to do an Annuity IRA
Logistically, it’s easy to open an IRA annuity account. As you fill out paperwork with the annuity company, let them know that you want to open the account as an IRA. If you’re rolling money into the annuity, you’ll need to let them know that the money is coming from another retirement account. If you’re just writing checks to the account, be sure to keep the annual contribution limits in mind.
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