Annuities and individual retirement accounts both provide ways to defer taxes on savings, but buying an annuity for your IRA doesn't yield some sort of double tax break. For persons a long way from retirement, an IRA annuity doesn’t make much sense. It restricts the primary benefit of holding an annuity – no contribution limits – and it adds a second layer of fees, hobbling your investment returns. But insurance companies – and the Internal Revenue Service – don't make it easy to exchange an IRA annuity for something else.
An annuity is an insurance contract that provides monthly payments for a specified period, perhaps as long as you live. Annuities also usually carry a death benefit if you die before receiving a designated number of payments. Persons far from retirement typically get a deferred variable annuity. Payments begin sometime down the road, and distribution amounts depend on the value of the account when the payments are scheduled to begin. You affect that value by the investment choices you make, typically ranging from fixed-interest vehicles to a basket of investments, usually mutual funds.
Buying an annuity with an IRA restricts the amount you can contribute to $5,000 a year -- at least for persons under 50. Plus, you can invest only in the products offered by the annuity, usually mutual funds or fixed-income products, such as CDs or interest-bearing accounts. Annuities typically carry their own set of -- usually -- high fees; you'll pay additional fees to your IRA custodian.
Rolling over an annuity to a regular IRA is tax-free and allows you access to a wider range of investment options. You can get into real estate and commodities as well as stocks, bonds, mutual funds, CDs and savings accounts. If you keep the same IRA home, you need only to notify the custodian, which will extract the money from the annuity for you. If you change plans, you must close the annuity and deposit the funds you receive into your new IRA account. You have 60 days to complete the transaction or pay taxes on the liquidation, plus a 10 percent early withdrawal penalty unless you're 59 1/2.
Before initiating a rollover, check with your annuity provider for surrender charges. Annuities often charge early-out fees that decrease with each year you own the policy. In some cases, high surrender charges may negate any benefits from a rollover.
Annuities often make up the 403(b) workplace retirement plans for some teachers and employees of nonprofit institutions. You can roll over a 403(b) plan tax-free into an IRA, but you can't avoid any surrender charges included in the annuity program. In some cases, it's better to leave the money inside the 403(b) -- even if you switch jobs -- rather than pay a high surrender charge.
Inherited IRA Annuity
If you inherit an IRA annuity, you can roll it over to a traditional IRA only as your spouse's beneficiary. All payments from an inherited IRA annuity are fully taxable, but there are a couple of ways to spread out the tax hit. Before a lump sum payment is processed, you can specify annual payments up to five years after the year of death. The tax liability will be deferred until the time you get the money. If the annuity provider and your IRA custodian allow it, you can make a trustee-to-trustee transfer to an appropriately titled inherited IRA, which allows for payments over the lifetime of the beneficiary. In any case, if you qualify for, but can't afford, deductible IRA contributions, you can make them using inherited IRA annuity payments, deferring your tax liability until you take IRA distributions.
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- How to Disclaim an IRA
- How to Rollover a 403(b) Plan to an IRA
- How Does a Stretch IRA Work?
- Can You Roll Over an IRA Into a Non-Taxable Annuity?
- Do the Disabled Qualify for a Roth IRA?
- How to Report a Roth IRA Surrender