Can You Buy an Annuity With Your IRA?

An Individual Retirement Account (IRA) is a retirement savings plan that offers tax advantages for growing retirement funds. It serves as a personal savings tool, separate from employer-sponsored plans, allowing individuals with earned income to save for their future. An annuity, conversely, is a contract between an individual and an insurance company designed to provide a guaranteed income stream, typically during retirement. This financial product involves making payments to an insurer in exchange for regular disbursements later on. It is generally possible to hold an annuity within an IRA, combining the tax benefits of the retirement account with the income features of an annuity.

Eligibility and Compatibility

Various types of Individual Retirement Accounts are generally eligible to hold annuities. Traditional IRAs, Roth IRAs, Simplified Employee Pension (SEP) IRAs, and Savings Incentive Match Plan for Employees (SIMPLE) IRAs can all accommodate annuity contracts. The decision to place an annuity within an IRA often aims to leverage the annuity’s income guarantees within a tax-advantaged retirement structure.

Annuities commonly held within IRAs include fixed annuities, variable annuities, and indexed annuities. A fixed annuity offers a guaranteed interest rate for a set period, providing predictability and principal protection from market volatility. Variable annuities, on the other hand, carry more investment risk as their value fluctuates based on the performance of underlying investments, but they also offer potential for higher returns. Indexed annuities combine features of both fixed and variable annuities, with returns tied to a market index while often including some protection against market downturns.

While an IRA already provides tax-deferred growth, placing an annuity inside it does not offer additional tax deferral benefits. Instead, the primary motivation is often to integrate the annuity’s contractual guarantees, such as a guaranteed lifetime income stream, into the broader retirement plan. For instance, a fixed deferred annuity is often considered suitable for an IRA, as it can diversify a portfolio with reliable growth and principal protection.

The Acquisition Process

Acquiring an annuity within an IRA involves specific procedural steps to ensure proper titling and adherence to IRS regulations. This process can be initiated either by purchasing an annuity with new IRA contributions or by transferring existing IRA funds. When using new contributions, the individual makes an IRA contribution, and then directs those funds to purchase an annuity contract within that IRA. The annuity must be titled in the name of the IRA for it to be considered an IRA-owned annuity.

Transferring existing IRA funds to purchase an annuity typically occurs through a direct trustee-to-trustee transfer. In this method, funds move directly from the current IRA custodian to the annuity provider without the account holder taking possession of the money. This direct transfer helps avoid potential tax consequences and simplifies the administrative process.

Alternatively, an indirect rollover, also known as a 60-day rollover, involves the IRA owner receiving the funds from their existing IRA and then depositing them into a new IRA or annuity within 60 days. If the funds are not redeposited within this 60-day window, the IRS treats the withdrawal as a taxable distribution, and it may be subject to a 10% early withdrawal penalty if the individual is under age 59½. Due to these complexities and potential tax implications, direct trustee-to-trustee transfers are generally preferred for moving funds to an annuity within an IRA.

Tax Implications and Withdrawals

Annuities held within an IRA maintain the tax treatment of the underlying IRA, meaning contributions and earnings grow on a tax-deferred basis until withdrawal. For a Traditional IRA, distributions from the annuity are taxed as ordinary income in retirement. In the case of a Roth IRA, contributions are made with after-tax dollars, and qualified withdrawals, including those from an annuity held within it, are tax-free.

Required Minimum Distributions (RMDs) apply to annuities held within Traditional, SEP, and SIMPLE IRAs, generally starting at age 73. The RMD amount is calculated annually based on the annuity’s value at the end of the prior year and the account holder’s life expectancy, as determined by IRS tables. Failure to take the full RMD can result in a penalty of 25% of the amount not distributed. While annuities can provide a steady income stream, the RMD rules ensure that tax-deferred savings are eventually distributed and taxed.

Early withdrawals from an IRA-owned annuity before age 59½ are generally subject to a 10% federal income tax penalty, in addition to ordinary income tax on the taxable portion of the distribution. This penalty applies unless a specific IRS exception is met. Upon the death of the IRA owner, beneficiaries of an IRA annuity will typically inherit the contract, and distributions to them will be subject to RMD rules and taxation based on the IRA type.