How to Use an Annuity for a Down Payment

Using annuity money for a down payment might not be the wisest decision.

Using annuity money for a down payment might not be the wisest decision.

If you believe you're ready to take that first step toward home ownership, but you're a little short on cash for the down payment, take a moment to consider the possible consequences before you fax in that annuity withdrawal request form. Annuity contracts, IRS regulations and real estate sales are already complex products and services individually. When you're talking about choices that directly affect, and are affected by, each of these things, it's best to have a clear understanding of the pros and cons of each contract as it relates to your situation.

Annuity Basics

Annuities are retirement investment vehicles created, managed and maintained by life insurance companies. Money deposited into these types of accounts accumulates tax-deferred until it is withdrawn. Several types of annuity contracts are available from countless insurance carriers, and not all annuities are suitable or appropriate for every investor. Using these retirement funds to secure a real estate purchase may, at first glance, appear an easy way to come up with the money. However, if your situation doesn't exactly meet the criteria set by Uncle Sam and the insurance company, you might cost yourself quite a bit of money in the long run.

IRS Early Withdrawal Penalties

Money held within an annuity, or any other qualified retirement arrangement, cannot ordinarily be freely withdrawn before the year during which the account holder reaches age 59 1/2. If you take money from your annuity to fund your down payment, you may be forced to pay an additional 10 percent penalty tax on the amount withdrawn in addition to the ordinary income taxes due on the early distribution.

Insurance Carrier Surrender Charges

Separate from Uncle Sam's 10 percent early withdraw penalty are the insurance company's own fees and charges for taking back your money before you're supposed to. Nearly every annuity contract contains surrender provisions that allow the carrier to keep a portion of your money if you withdraw it within the first several years. Every annuity is different, but surrender penalties often range from five to 10 percent, and the expiration of those fees may range from five to 15 years.

Exceptions to the Rule

While few exceptions exist for avoiding the insurance company's surrender penalties, the government will waive its 10 percent penalty if "you use the distributions to buy, build, or rebuild a first home," according to the IRS. Normal income tax will still be due on the amount you withdraw, but no extra fee is assessed. However, insurance companies don't typically waive surrender charges for home purchases.

The Good, The Bad, The Ugly

Think carefully about the ramifications of using annuity money to fund your down payment, especially if you're not purchasing your very first home. You might get hit with taxes and penalties from both the insurance company and Uncle Sam, leaving you with much less money than you assumed you'd have. Plus, even if your annuity is already out of the surrender period and you meet the IRS criteria for real estate purchases, you might still be causing irreparable damage to the stability of your retirement savings.

About the Author

Gregory Gambone is senior vice president of a small New Jersey insurance brokerage. His expertise is insurance and employee benefits. He has been writing since 1997. Gambone released his first book, "Financial Planning Basics," in 2007 and continues to work on his next industry publication. He earned a Bachelor of Science in psychology from Fairleigh Dickinson University.

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