Can You Rollover an IRA Into an Annuity?

An Individual Retirement Account (IRA) serves as a tax-advantaged savings vehicle designed to help individuals prepare for retirement. An annuity represents a contract typically issued by an insurance company, structured to provide a steady stream of income, often during retirement. It is possible to roll over an IRA into an annuity, allowing funds to maintain their tax-deferred status while potentially benefiting from income guarantees.

Understanding Annuities for IRA Rollovers

Annuities operate in two main phases: the accumulation phase and the payout, or annuitization, phase. During the accumulation phase, funds contributed to the annuity grow on a tax-deferred basis, meaning taxes are not paid on earnings until withdrawals begin. The payout phase commences when the annuity owner starts receiving income payments, which can be structured in various ways, such as for a specific period or for life.

Different types of annuities offer varied growth and income features. A fixed annuity provides a guaranteed interest rate for a set period, offering predictable growth and income streams. Variable annuities, however, involve investments in underlying sub-accounts that function much like mutual funds, exposing the contract value to market fluctuations and potential gains or losses. Indexed annuities link their returns to a specific market index, like the S&P 500, providing growth potential without direct market participation and often including some principal protection.

When considering an IRA rollover, it is important to understand the distinction between “qualified” and “non-qualified” annuities. A qualified annuity is funded with pre-tax dollars, often originating from retirement accounts such as IRAs or 401(k)s. This means that both contributions and earnings grow tax-deferred, and all distributions in retirement are taxed as ordinary income.

Non-qualified annuities are funded with after-tax dollars, meaning only the earnings portion of distributions is subject to taxation. Since an IRA consists of pre-tax contributions, transferring these funds into an annuity automatically designates it as a qualified annuity.

The IRA to Annuity Rollover Process

Transferring funds from an IRA into an annuity involves specific steps to ensure tax-deferred status is maintained. The two primary methods for executing this transfer are a direct rollover and an indirect rollover.

A direct rollover, also known as a trustee-to-trustee transfer, is the most common and recommended approach. In this method, funds are moved directly from the IRA custodian to the annuity provider, an insurance company, without the account holder ever taking possession of the money. This seamless transfer prevents any tax withholding and avoids a taxable event, making it the most straightforward way to roll over IRA funds. There are no limits on the number of direct rollovers an individual can perform in a year.

Alternatively, an indirect rollover, or 60-day rollover, involves the IRA holder receiving the funds directly from the IRA custodian. The account holder then has a strict 60-day window from the date of receipt to redeposit the entire amount into a new IRA or qualified annuity to avoid taxes and penalties. If the funds are not redeposited within this 60-day period, the withdrawal is treated as a taxable distribution, and if the individual is under age 59½, an additional 10% early withdrawal penalty may apply. The Internal Revenue Service (IRS) limits indirect IRA-to-IRA rollovers to one per 12-month period.

Initiating a rollover requires contacting both the current IRA custodian and the chosen annuity provider. Paperwork, including transfer forms and annuity applications, must be completed to facilitate the movement of funds. Selecting the appropriate annuity product, based on individual financial goals and risk tolerance, is also part of this process.

Tax and Contractual Considerations

Once an IRA has been rolled into a qualified annuity, the tax treatment of future distributions aligns with that of traditional IRA withdrawals. All distributions, including both the original principal and any accumulated earnings, are taxed as ordinary income at the individual’s marginal tax rate in the year they are received.

Qualified annuities holding IRA funds remain subject to Required Minimum Distribution (RMD) rules once the account owner reaches the mandated age. For individuals born between 1951 and 1959, RMDs generally begin at age 73; for those born in 1960 or later, they start at age 75. The RMD amount is calculated annually based on the annuity’s value at the end of the prior year, divided by a factor from the IRS Uniform Lifetime Table. Failure to take the full RMD by the deadline can result in a significant penalty.

Annuity contracts often include surrender charges, which are fees imposed if money is withdrawn beyond a certain amount or if the contract is terminated during an initial period. These surrender periods typically range from three to ten years. Surrender charges are usually a percentage of the amount withdrawn and often decline each year the contract is in force, starting, for example, at 7% or 8% in the first year and gradually decreasing to zero. Many annuities allow for a “free withdrawal” provision, permitting withdrawals of a small percentage, commonly 10% of the contract value, annually without incurring a surrender charge.

Beyond surrender charges, annuities, particularly variable annuities, can have other associated fees. These may include mortality and expense (M&E) risk charges, which compensate the insurance company for guarantees. Administrative fees, covering record-keeping and maintenance, might be a flat annual fee or a percentage of the account value. Underlying investment fees for sub-accounts in variable annuities are also common. Additionally, optional riders, which provide enhanced benefits like guaranteed income or death benefits, come with their own annual costs.

Annuities are subject to suitability requirements, meaning that a financial professional must have a reasonable basis to believe the product is appropriate for an investor’s financial situation and objectives. Regulatory bodies, such as FINRA and state insurance departments, have rules that mandate a thorough assessment of an investor’s age, income, investment experience, and risk tolerance before recommending an annuity.