Is It a Good Idea to Keep an Annuity in an IRA?
By Steven Miszkowicz, CISP
Is it a good idea to keep an annuity in an IRA? The answer to that question, of course, depends on the individual investor. (I know, that’s the standard answer to all financial advice questions.) And while that answer can be frustrating, it’s worth knowing when an annuity might make sense in an IRA and when an annuity might be a waste of investment dollars.
There is much debate between experts and individual investors about whether to keep an annuity in an IRA. The truth is that while an IRA annuity may not make sense for one investor, it may make perfect sense for another. Keep reading to understand when an IRA annuity can be advantageous to an investor’s retirement outlook and when it would not be.
But First, What Is an IRA Annuity?
Simply put, an IRA annuity is an annuity that is purchased with funds inside an IRA and is held within the IRA. Investors can use their IRA funds to purchase an annuity in the same way they can purchase stocks, bonds, mutual funds, or ETFs. However, unlike other IRA investments, IRA annuities cannot typically be transferred to another beneficiary upon your death (although there are some exceptions to this).
You can only use 25% of your IRA balance or $135,000 (whichever is less) to purchase an annuity for your IRA. Additionally, IRA annuities are still subject to required minimum distributions (RMDs) if held within a traditional IRA. As you’ll see below, some specific annuity strategies can help investors meet RMDs in specific situations. If an IRA annuity is held in a Roth IRA, it is of course not subject to RMDs.
Arguments Against Annuities in an IRA
One of the main arguments against having an annuity in an IRA is that both come with tax deferral benefits. Many experts believe that it does not make sense to purchase a tax-deferred investment product to be held within a tax-deferred account. (In fact, this strategy has been likened to wearing a raincoat inside or putting on two pairs of socks instead of one.)
Additionally, annuities typically come with high annual fees. An average variable annuity can have fees as high as 2.3% of the contract value or even above 3%. This type of product can easily chip away at an investor’s bottom line, especially when taking into account other fees investors pay on the other investments in their portfolio.
Finally, a significant argument against holding an annuity in an IRA is the opportunity cost. Annuities are expensive products and require large amounts of cash to generate a monthly income payment that is substantial enough to make a difference for most retirees. Investors who purchase an annuity product lose control of their principal and risk missing out on huge gains from other investments. Annuities should never be considered a growth opportunity.
Arguments For Annuities in an IRA
However, for highly risk-averse investors, annuities are most attractive for their guaranteed lifetime income benefit. After all, investors can’t control the markets and they can’t predict how long they’ll need to generate income in retirement. Annuities can offer some peace of mind that retirees will always be able to depend on a certain amount of income each month in retirement.
Pre-retirees who are quickly approaching retirement and do not feel at all comfortable with their guaranteed income from Social Security may find some peace of mind supplementing Social Security benefits with income from an annuity.
If the purpose of purchasing an annuity is for reasons other than the tax-deferral benefits, it can make sense for some investors to hold an annuity in their IRA. Additionally, investors who are already making maximum contributions to tax-deferred retirement accounts and are looking for other ways to defer taxes may wish to purchase an annuity, as there are no contribution limits.
For investors who do not plan to use their IRA balances for retirement income, an IRA annuity can help to offset or cover RMD rules for investors who are above age 79½ (or age 72 after 2019). If the annuity payment covers the RMD amount, investors can use the annuity payments to allow the remainder of their IRA balance to continue benefiting from investment growth.
Many annuities also provide unique rider options that can be added to the contracts, which can help retirees plan for other concerns in retirement. For example, many annuities offer a long-term care rider that retirees can take advantage of if they ever need to make use of long-term care services.
Finally, the simplest reason to purchase an annuity with IRA funds is that many investors don’t have the capital outside of an IRA to purchase a favorable annuity contract. Much of their wealth is contained within their IRA or 401(k) account, so if they’re interested in an annuity for one of the reasons listed above, they want to use the funds they’ve already been saving for retirement.
So Do You Need an Annuity in your IRA?
If you’re considering including an annuity in your IRA, make sure to research any product you’re considering in as much depth as you would research other investments. You should review the contracts of any annuities you look at and ensure you understand all the associated fees and commissions.
If you’ve created an investment strategy with a financial advisor, be sure to consult your advisor about this decision. And above all, be honest with yourself about why you’re considering an annuity in your IRA. Weigh that decision against other opportunities available to you so you make the best decision for your circumstances and goals.
How Chicago Trust Administration Services Can Help
As inflation continues to rise and market volatility remains a concern, retirees, pre-retirees, and young investors alike are looking for the best ways to diversify their portfolios and generate reliable income in retirement. You have many options available to you besides stocks, bonds, mutual funds, ETFs, life insurance policies, and annuities.
At Chicago Trust Administration Services, we help investors make nontraditional investments using a self-directed IRA. Whether you want to use your IRA to invest in real estate, private equity, peer-to-peer lending, or another alternative asset, we can help you make the transaction efficiently while adhering to IRS compliance regulations.
To see how we can help, we invite you to schedule a complimentary meeting with us by calling 312-869-9394 or emailing steve@ctasira.com.
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*The content and opinions in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
**CTAS professionals are not financial advisors and cannot provide advice or recommendations regarding specific investment decisions.