Should annuities be inside your IRA?
There is an ongoing argument in the financial world of whether an annuity should be held within an Individual Retirement Account. As with most money issues, the answer isn’t a simple yes or no.
The consistent annuity haters are always going to say no to any annuity, whether it’s held in an traditional IRA structure or a non-qualified (non-IRA) account. The vast majority of financial curmudgeons equate having an annuity within an IRA to wearing two pairs of socks, or using a belt in conjunction with suspenders. This line of thinking is especially prevalent when the idea of having a tax-deferred annuity within a tax-deferred IRA structure is recommended.
The obvious arguments and ridiculous examples are intellectually lazy and missing the point in my opinion, so let’s take a look at the valid arguments for and against having an annuity within an IRA.
As we all know, when you turn 70 ½ the IRS taps you on the shoulder and reminds you that it’s time to start taking money out of your traditional IRA whether you need it or not. This IRS requirement is called the Required Minimum Distribution, or RMD. RMD’s happen every year, and is something that you have to plan for in order to cover this annual tax commitment. Single Premium Immediate Annuities can help either offset or fully cover your RMD requirement while providing a lifetime income stream in the process.
Lifetime income annuities can also be set up to pay joint life with your spouse, even though it’s in your personal IRA. They also can be structured so that the insurance company doesn’t keep a dime, and 100% of any unused money goes to your listed beneficiaries. You can also add a cost of living adjustment rider (COLA) to your income annuity that will contractually increase your income stream for as long as you live, but this feature will lower your initial payout.
An IRA is like a house, and the furniture inside are the investments you choose to keep there. Because an IRA is already tax deferred, you can’t get double tax deferral if you put a deferred annuity inside of your IRA. Regardless of whatever type of investment you have inside of your traditional IRA, when you decide to or are forced to take money out, it will be taxed the same.
If you are considering an annuity in your IRA, you have to look at the annuity like any other investment choice. Ask yourself if the annuity policy can contractually achieve your goals. Also figure out what do you want the money to do, and if an annuity is the best choice. For example, if principal protection is the goal, then maybe a fixed-rate or indexed annuity would be an appropriate product.
For those of you that aren’t planning on accessing your IRA except through Required Minimum Distributions (aka: RMDs), there are specific annuity strategies that might be an appropriate choice to leave a legacy to your heirs. Some deferred annuities have a contractual death benefit rider that you can add to the policy that will grow at a specific percentage while offsetting RMD’s at the same time. When structured properly and combined with the right death benefit rider guarantee, you will be able to take RMD’s for as long as you live and not decrease the principal.
Because I only view annuities as contractually guaranteed transfer of risk products, placing an annuity within your IRA to achieve market growth is a nonstarter due to their investment limitations. Variable annuities were developed in 1952 for tax deferred growth, so in my opinion, they are best used in non-IRA accounts. True growth potential can be optimally achieved in your IRA with non-annuity choices.
Fees can also be an issue if you choose to place a deferred annuity within your traditional IRA. Some fully loaded variable annuities have annual fees as high as 3% to 4%, and indexed annuities with riders can have annual fees of 1% or more.
Buying a single premium immediate annuity within your traditional IRA to cover or offset your RMD’s will efficiently create a lifetime income stream, but you will also give up access and control of that principal amount in order to achieve the desired transfer of risk. That’s the trade off — and a downside to some.
The main argument against putting an annuity inside of a traditional IRA is what detractors call “opportunity cost.” Locking your money up in a deferred annuity or losing control of the principal with an immediate annuity are legitimate reasons for not placing annuity furniture inside the IRA house.
Roth IRA argument
For those of you who have been so patriotic to pay your taxes up front, and trust our politicians to leave the current Roth IRA rules in place, then you also need to look at annuities from a pure product value standpoint. If growth is your goal for the Roth IRA, then an annuity is probably not going to be your best choice. However, if you want a lifetime income stream, then an immediate annuity strategy could provide the tax free stream you are looking for.
So the next time some financial expert says that you should never put an annuity inside of an IRA, you know that “blanket statement” isn’t always true. Like most financial decisions and plans, everything is customized and not one size fits all.
Potentially having an annuity inside of your IRA could be a good move or a bad move. It all depends on what you are specifically trying to achieve.
Originally published by MarketWatch.com 9.24.13 – http://www.marketwatch.com/story/should-annuities-be-inside-your-ira-2013-09-24