Can You Rollover a 401(k) to an Annuity?

Retirement planning often involves converting savings into a reliable income stream. Many explore rolling over 401(k) funds into an annuity to establish a consistent payout during retirement.

Understanding Annuity Types for Retirement Planning

An annuity is a contract with an insurance company where an individual pays a premium for regular payments, starting immediately or in the future. Designed for retirement, annuities convert a lump sum or series of payments into guaranteed distributions.

Fixed annuities offer a guaranteed interest rate during their accumulation phase, providing predictable growth and principal protection. The rate is set by the insurance company and remains unaffected by market fluctuations. After the initial guaranteed period, the interest rate may be reset, but it typically cannot fall below a contractually guaranteed minimum.

Variable annuities, in contrast, allow for investment in underlying sub-accounts, which are similar to mutual funds, offering potential for growth but also exposing the investor to market risk. The value of the annuity and subsequent payments can fluctuate based on the performance of these chosen investments.

Indexed annuities link their returns to a specific market index, such as the S&P 500. These annuities often include features like a “cap,” which is the maximum percentage of index growth credited, a “floor,” which guarantees a minimum return (often zero), and a “participation rate,” determining the percentage of the index’s gain credited to the annuity. This structure aims to provide some market-linked growth while protecting against losses.

Annuities can also be classified by when payments begin: immediate or deferred. An immediate annuity typically starts providing income payments within 12 months of purchase, often funded by a single lump sum. Deferred annuities, on the other hand, have an accumulation period during which funds grow before income payments commence at a later, specified date.

401(k) Rollover Eligibility and Options

Funds can be rolled over from a 401(k) when leaving employment, reaching a certain age, or if the plan terminates. Separating from an employer typically makes 401(k) assets eligible for transfer to another qualified account, like an annuity or Individual Retirement Account (IRA).

In-service distributions refer to withdrawals or rollovers made while still employed by the company sponsoring the 401(k) plan. While some plans permit in-service distributions at any age for certain account types, a common threshold for penalty-free withdrawals is reaching age 59½. At this age, participants can generally take distributions without incurring the 10% early withdrawal penalty, though income taxes still apply to pre-tax funds. Some plans may also allow rollovers of prior employer contributions or rollover contributions at any time.

When a 401(k) plan is terminated by the employer, participants are typically required to move their funds out of the plan. In such cases, rolling over the assets to an IRA, including an annuity held within an IRA, or to a new employer’s plan are common options. Plan administrators will provide specific instructions and deadlines for these rollovers.

There are two primary methods for rolling over 401(k) funds: direct and indirect rollovers. A direct rollover involves the funds being transferred directly from the 401(k) plan administrator to the new annuity provider or custodian. This method is generally preferred because it avoids immediate tax consequences and withholding. The funds move without the individual ever taking physical possession of the money, maintaining its tax-deferred status.

An indirect rollover, also known as a 60-day rollover, occurs when funds are first distributed to the individual. The individual then has 60 days from receipt to deposit the money into another qualified retirement account, such as an annuity. The plan administrator is required to withhold 20% of the distribution for federal income tax. To complete a tax-free indirect rollover, the individual must deposit the full amount, including the 20% withheld, into the new account within the 60-day window.

Initiating the 401(k) to Annuity Rollover

Initiating a 401(k) to annuity rollover requires careful attention to detail and communication with both the current 401(k) plan administrator and the chosen annuity provider. Before beginning the process, gather your most recent 401(k) statement, which includes account and administrator contact information, and personal identification documents.

When selecting an annuity, the annuity provider will require specific details for the new contract. This includes the annuity provider’s name, the contract number, and beneficiary designation details. Both the 401(k) plan administrator and the annuity provider will supply the necessary forms to facilitate the transfer, which will prompt for your gathered account and personal data.

The procedural steps for the rollover typically begin by contacting the 401(k) plan administrator to inform them of the intent to roll over funds. They will provide the required distribution forms and explain their specific rollover procedures. Simultaneously, the individual should contact the chosen annuity provider to initiate the new annuity contract; the annuity provider will also have forms that need to be completed, often including a rollover request form.

Once all forms are accurately completed and signed, they must be submitted to the respective parties. For a direct rollover, the 401(k) administrator will typically send the funds directly to the annuity provider, either electronically or via a check made payable to the annuity company. After the funds are transferred, it is advisable to monitor the transfer process to ensure the funds arrive in the new annuity account as expected. This can involve checking account statements from both the 401(k) and annuity providers.

A direct rollover of 401(k) funds to an annuity is generally non-taxable, with funds growing tax-deferred. For indirect rollovers, where funds are received directly, a mandatory 20% federal income tax withholding applies. To avoid the distribution being taxable and potentially subject to a 10% early withdrawal penalty (if under 59½), the full gross amount must be rolled into the annuity within 60 days. The withheld amount can be recovered as a tax credit.

Once funds are in the annuity, distributions from qualified annuities, meaning those funded with pre-tax 401(k) dollars, are generally taxed as ordinary income upon withdrawal. Required Minimum Distributions (RMDs) also apply to annuities holding qualified funds. Individuals must begin taking these minimum distributions from their qualified annuity by age 73, or age 72 if they turned 72 between 2020 and 2022. The RMD amount is calculated annually based on the annuity’s value and the individual’s life expectancy, and failure to take the RMD can result in a significant penalty, typically 25% of the amount not distributed. Annuity payments can count towards satisfying these RMD obligations.