Can Annuities Be Changed to an IRA without Tax Penalty?

by Mark Kennan, Demand Media
    Investors should consider the tax implications when moving money into an IRA.

    Investors should consider the tax implications when moving money into an IRA.

    If you're not the type to kick back and let your money sit in an annuity, you might be looking for ways to move it into another account that not only will keep the tax-sheltered growth, but also give you more flexibility in your investments. Though an IRA offers that flexibility, whether you can move the annuity to an IRA depends on whether it's part of a qualified plan.

    Qualified Annuities

    IRAs can only accept transfers from qualified plans. If your annuity is part of a qualified plan, such as a 403(b) or 401(k) plan, and you're eligible to roll the money into another plan, you can move the money into an IRA. You might choose to move the money if the annuity's fees are too high, you think you can do better with alternative investments or you'd rather consolidate all your retirement funds into one IRA.

    Change Methods

    You can move the money from the annuity in a qualified plan to an IRA with either a rollover or a transfer. Generally, the transfer's going to be your best option, because the proceeds can go straight into the IRA without you having to handle the money. That way, no withholding penalty is taken and you don't have to worry about reporting it on your taxes. The alternative is using a rollover, where you take a distribution from the annuity in the qualified plan and then you deposit it in the IRA. However, 20 percent will be withheld and you'll have to report the rollover on your taxes.

    Nonqualified Annuities

    If you have an annuity that isn't part of a qualified retirement plan, such as a commercial annuity you purchased on your own, you're out of luck. Because it's not part of a qualified plan, it isn't eligible to be rolled into an IRA. If you take the money out of the nonqualified annuity, you probably will have to treat the earnings as taxable income and, if you are under 59 1/2 years old, pay a 10 percent additional tax on the earnings.

    Effects of Moving Money from a Nonqualified Annuity

    If you attempt to move money from a nonqualified annuity to your IRA, the IRS treats you as if you made a regular contribution to the account, subject to the annual limits. The annual limits can be quite limiting -- at $5,000 as of 2012. If you contribute less than that about, you're safe. However, if you contribute more than the annual limit to the account in a given year, you have to pay a 6 percent excess contribution penalty. Worse, the penalty keeps hitting your taxes every year until you correct the excess.

    About the Author

    Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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