An individual retirement account (IRA) can easily be converted to an annuity without an impact on taxes, provided the accounts have the same tax status. Traditional IRAs and annuities were designed to allow money to grow tax-deferred for retirement. Directly transferring money from one vehicle to the other doesn't count as a withdrawal and isn't taxed.
Annuities are retirement savings vehicles that are used to provide a steady stream of income for retirement. There are three main types of annuities: fixed, variable and indexed. In a fixed annuity, the money earns a specific interest rate and guarantees a set payment amount for a defined period, such as through the account holder’s lifetime. Variable annuities allow account holders to choose from a variety of investment options. As a result, the money paid out can fluctuate greatly based on the performance of the investments. Indexed annuities fall somewhere in between. They are tied to the performance of a market index, such as the S&P 500. Some indexed annuities offer a minimum return, making them less risky than a variable account.
Converting a traditional, tax-deferred IRA to a tax-deferred annuity should have no tax effect. Moving the money is essentially a rollover. The critical thing is to make sure your IRA trustee issues the check to the trustee or insurance company providing the annuity. Since taxes are paid on money received from the account as a withdrawal, the account holder doesn't want the check paid to him or her. If it is, taxes are taken out.
Traditional IRAs and Taxes
Money in a traditional retirement IRA or annuity grows tax-deferred, which means putting off paying taxes on the money until the money is withdrawn. When money is withdrawn from this type of IRA or annuity through regular payments, that money is treated as income. It is reported as part of your regular income for tax purposes that year. If money is withdrawn from a retirement account prior to the account holder turning 59 1/2, a flat 20-percent tax penalty will be applied off the top.
Roth IRAs and Annuities
A Roth IRA is funded with post-tax dollars, meaning taxes were already paid on the money invested. The money earned on the investment is also not taxed. With a Roth account, contributions can generally be withdrawn anytime. However, earnings may be subject to a penalty, depending on how old the account is, the account holder's age, or circumstances such as death, disability or a qualified home purchase. Since money can be withdrawn, and Roth accounts are relatively new, converting a Roth IRA to an annuity isn't common. But, one potential advantage to converting a Roth IRA to an annuity in the future is the steady income stream in retirement that annuities provide.
Dyanne Weiss has more than 20 years experience in human resources and corporate communications. Her communications strategies' have aided employee engagement and understanding of health care benefits, retirement planning, performance planning and compensation. Weiss has also worked in several industries: energy, insurance, banking, financial planning and health care. She has an MBA in management and organizational behavior.