Can You Roll an IRA Into an Annuity?

An Individual Retirement Account (IRA) is a tax-advantaged savings vehicle for retirement, offering benefits like tax-deferred growth or tax-free withdrawals. An annuity is a contract with an insurance company that provides regular payments, often for life, with earnings growing tax-deferred. It is possible to transfer funds from an IRA into an annuity, combining the benefits of both.

Mechanics of Rolling an IRA into an Annuity

Transferring IRA funds into an annuity involves specific steps to maintain their tax-deferred status. This can occur through a direct or indirect rollover.

A direct rollover, also known as a trustee-to-trustee transfer, is the most straightforward method. Funds move directly from the IRA custodian to the annuity provider without the account holder taking possession. This ensures the transfer remains tax-free.

An indirect rollover involves the IRA holder receiving a distribution, which must be deposited into another qualified retirement account, like an annuity, within 60 days. Failure to redeposit within this window makes the distribution taxable as ordinary income and may incur a 10% early withdrawal penalty if under age 59½. The IRS limits indirect IRA-to-IRA rollovers to one per 12-month period, treating all IRAs as a single account for this rule. Proper titling of the new annuity contract is important to keep funds within the IRA’s tax-advantaged framework.

Understanding Annuity Types for Rollovers

Understanding annuity types is important when considering an IRA rollover, as each offers varying growth potential and risk. Different types include fixed, variable, and indexed annuities.

Fixed Annuity

A fixed annuity provides a guaranteed interest rate for a specified period, similar to a certificate of deposit. It offers predictable growth, securing principal and interest if the issuing company is solvent. These are often chosen by those seeking stability and guaranteed returns.

Variable Annuity

A variable annuity allows funds to be allocated among various investment options, often resembling mutual funds. Its value fluctuates with underlying investments, meaning returns are not guaranteed and carry potential for gains or losses. While offering greater growth potential, variable annuities also carry investment risk, suitable for those comfortable with market volatility.

Indexed Annuity

An indexed annuity, or fixed indexed annuity, offers returns linked to a market index, such as the S&P 500. It typically includes a principal guarantee and a minimum interest rate. Indexed annuities often cap maximum interest or use participation rates, limiting upside potential for downside protection. This hybrid structure provides market participation while safeguarding the initial investment.

Tax Implications of IRA to Annuity Rollovers

Rolling an IRA into an annuity generally allows funds to maintain their tax-deferred status, meaning taxes are not paid on earnings until distributions begin. This permits the investment to grow without annual taxation on gains. When distributions are taken from the annuity, they are typically taxed as ordinary income, similar to withdrawals from a traditional IRA. If the annuity was funded with pre-tax dollars, the entire amount of each withdrawal or payment will be subject to income tax.

Required Minimum Distributions (RMDs) also apply to annuities held within an IRA once the account holder reaches age 73. The annuity’s value is included when calculating the total RMD from an individual’s IRA holdings. Payments received from the annuity can be used to satisfy the RMD requirement for the year. If distributions are taken from the annuity before age 59½, they may be subject to an additional 10% IRS penalty, unless a specific exception applies, in addition to being taxed as ordinary income. Understanding these tax rules is important for managing income in retirement and avoiding unexpected penalties.

Key Factors When Considering an Annuity Rollover

An annuity rollover from an IRA involves assessing several practical and financial factors. These include fees, liquidity, and beneficiary designation.

Fees

One significant consideration is the presence and impact of fees. Annuities commonly include surrender charges, which are penalties for withdrawing funds or canceling the contract within a specified period, typically ranging from six to ten years after purchase. These charges can be substantial, often starting around 7% to 8% of the withdrawn amount and gradually decreasing over the surrender period. Many contracts allow for a penalty-free withdrawal of a small percentage, such as 10% of the account value, annually.

Beyond surrender charges, annuities may have other costs, including mortality and expense (M&E) risk fees, administrative fees, and charges for optional riders. M&E fees, typically ranging from 0.40% to 1.75% annually, compensate the insurance company for guarantees and risks assumed, such as death benefits. Administrative fees cover contract management and record-keeping, often around 0.10% to 0.50% of the contract value or a flat annual fee. Optional riders, which add features like guaranteed lifetime income or enhanced death benefits, also incur additional fees, often between 0.25% and 1% of the contract value.

Liquidity and Beneficiary Designation

Liquidity is another important factor, as annuities are designed for long-term financial goals and generally limit access to funds without penalty. The combination of surrender charges and potential early withdrawal penalties can make accessing money before retirement both costly and restrictive.

Proper beneficiary designation is essential to ensure the annuity assets are distributed according to the owner’s wishes upon their death. Naming beneficiaries avoids the probate process, allowing for a more efficient transfer of assets. Reviewing and updating beneficiary designations periodically is important to reflect any life changes.