As you reach retirement age, you have options on how you’ll withdraw money from your IRA. Normally, you avoid a 10 percent early-withdrawal penalty if you wait until age 59 1/2 before siphoning money out of an IRA. You can draw money out on your own, but if you’d like a simple way to receive a fixed amount each month, consider converting the IRA into an annuity.
Insurance companies sell annuity contracts that offer fixed or variable payouts for a chosen period or for the rest of your life. The annuity provider invests your contribution in items such as bonds, stocks and mutual funds. The amount you’ll receive depends on the annuity’s initial balance, the payout period and your age. If you choose a variable annuity, the payout also depends on how well your investments do. Some annuities let you link your investment to an index of stocks or interest rates. Providers guarantee fixed payments as long as the annuity remains in effect. If you choose a lifetime fixed annuity, you’ll continue to get your payments even if you outlive your original contribution.
Qualified annuities offer the same tax treatment as you get from a traditional IRA. The Internal Revenue Service treats the money you rake in as ordinary income, subject to your marginal tax rate -- the tax on the “last dollar” of annual income. You won’t trigger any taxes if you have your IRA trustee transfer your money directly to the annuity provider. You can instead take the money out of your IRA and then contribute it to the annuity, as long as you get the job done within 60 days -- if you take longer, the IRS will tax you on the full amount. However, if you take this route, your trustee will withhold 20 percent of your money, and if you’re younger than 59 1/2, another 10 percent will be set aside in case you have to pay an early-withdrawal penalty.
Minimum Required Distributions
Traditional IRAs require you take begin taking distributions once you reach age 70 1/2. You figure your minimum required distribution based on your age and how long the IRS expects you to live (find the necessary tables in IRS Publication 590). Qualified annuities have the same requirement, although they use a different formula to figure the minimum annual distribution. Work closely with your annuity provider or financial advisor to make sure your withdrawals satisfy the IRS minimum distribution rules.
Before converting your IRA to an annuity, take some common-sense precautions to avoid unpleasant surprises. Some fixed annuity contracts offer high teaser rates for a period of time and then reduce your payments thereafter. You can protect yourself with a multi-year contract that guarantees the rate for the life of the annuity. Check whether the insurance company will charge you extra for taking the balance of your annuity in a single lump-sum payment or for surrendering the contract before a set number of years. Finally, understand the fees you’ll fork over for your annuity and whether you must buy life insurance as part of the deal.
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