How to Transfer an Annuity to an IRA

You can transfer an annuity into an IRA if it's already in an IRA or a pension plan. If the annuity was not in an IRA or pension, you must consider several things before you make a transfer. Annuities are already tax-sheltered, regardless of whether they're an IRA or other official pension plan, so when you remove the funds from them, you have to pay taxes regardless of your age. And if you're younger than 59 1/2, you may have to pay penalties as well. Before you move any money, consider the consequences of doing so.

Check the amount of money you have in the annuity. For the tax year 2010, you can't put in more than $5,000 per year if you're under 50, unless it's a transfer or rollover from a qualified account. This means the account was already money in a government-approved pension plan or IRA. If the money in the annuity is qualified, simply open an account and fill out the paperwork for a custodian-to-custodian transfer to an IRA in another annuity, a mutual fund or a bank product. There's no tax in that case.

Consider taxation and penalties. While you might not be able to remove the entire amount you have in your annuity, you can remove just enough for an IRA. But you'll receive taxes on the growth and a 10 percent penalty if you're under 59 1/2. The government considers money you take out to be "LIFO" -- last-in first-out -- and often, interest or growth is the last into the contract, so much of the money or all that you remove would be the growth. The tax and penalty you incur negates any tax benefits of an IRA.

See if you have to pay penalties on the early surrender of funds. If you just put money into an annuity, normally there's no growth to tax, but there might be early surrender penalties from the company. Look in the annuity contract table of contents under the section called "Surrender Penalties" to see how long your money has to stay in the annuity. Some companies allow a 10 percent penalty-free withdrawal. For example, if your deposit was $50,000 or more, the company would allow you to withdraw $5,000 and avoid surrender penalties on the money.

Ask your annuity company for a withdrawal form. You'll take what's called "constructive receipt" of the funds, regardless of where the company sends the check. This means that when you pay next year's taxes, you'll pay tax and penalty on the growth if you're under 59 1/2.

Deposit the check into your checking account, then open an IRA if the money was in an ordinary annuity. Write a check from your account for the IRA. You have a better tracking method when the check comes directly from your account. You can have the insurance company send the check sent directly to the IRA custodian if you'd like. This does not give you an opportunity to remove any funds necessary for taxes.

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