How Is an Immediate Annuity Funded?

A Single Premium Immediate Annuity (SPIA) is funded with a lump sum of money paid to an insurance company in exchange for a contractual income stream.

But where can that lump sum come from?

Depending on your situation, an Immediate Annuity can potentially be funded with:

• traditional IRA money
• Roth IRA money
• non-qualified money
• eligible retirement plan assets
• an existing annuity

The source of the funds doesn't change the fundamental lifetime income guarantee, but it can significantly affect taxation and how the transfer needs to be completed.

Key Takeaways

• Immediate Annuities are funded with a lump-sum premium.
• Funding can come from traditional IRAs, Roth IRAs, non-qualified assets, and other eligible sources.
• IRA-to-IRA transfers can generally be structured without creating a current taxable distribution.
• Existing annuities may potentially fund a new annuity through a qualifying 1035 exchange.
• Non-qualified Immediate Annuity payments generally consist of return of principal and interest.
• Choosing the funding source should come after determining the appropriate income structure.

What Is an Immediate Annuity?

A Single Premium Immediate Annuity is one of the oldest forms of annuity.

You provide a lump-sum premium to an insurance company, and the company contractually provides payments according to the structure you select.

Those payments can be established:

• for one lifetime
• for two lives jointly
• for a specified period
• with certain beneficiary protections

An Immediate Annuity is generally used when you want the income to begin within a relatively short period, typically within one year.

Start With the Income Need

Before deciding how to fund an Immediate Annuity, determine whether you need one.

Ask:

What do you want the money to contractually do?

When do you want those contractual guarantees to start?

If your answer is that you need lifetime income beginning soon, a SPIA may be worth comparing.

Then you can determine which funding source makes the most sense.

Funding an Immediate Annuity With an IRA

Traditional IRA assets are a common source of Immediate Annuity funding.

Many retirees have accumulated a substantial portion of their retirement savings inside:

• traditional IRAs
• 401(k)s
• 403(b)s
• 457 plans
• other qualified accounts

Depending on the situation, those assets may be transferred into an IRA annuity designed to provide the desired income.

When properly structured as a direct transfer, moving traditional IRA money from one custodian to an IRA at the annuity company generally doesn't itself create a taxable distribution.

The eventual income payments from a traditional IRA are generally taxable as ordinary income.

Funding an Immediate Annuity With a Roth IRA

Roth IRA assets may also be used to fund an Immediate Annuity.

The appropriate transfer structure maintains the Roth status as the money moves to the annuity company.

Qualified Roth IRA distributions are generally tax-free.

As with any retirement account transfer, make sure the transaction is completed properly so the tax status of the funds is preserved.

Funding an Immediate Annuity With Non-Qualified Money

You can also purchase an Immediate Annuity with non-qualified funds.

This generally means money that isn't held inside a tax-qualified retirement account, such as funds from a checking or savings account.

The money can be sent directly to the insurance company through the funding method accepted for the policy, such as a wire transfer or check.

The tax treatment of the resulting income differs from an Immediate Annuity held inside a traditional IRA.

How Are Non-Qualified Immediate Annuity Payments Taxed?

With a non-qualified Immediate Annuity, lifetime payments generally contain a combination of:

• return of principal
• interest

Because you've already paid taxes on the money used as principal, that portion isn't generally taxed again as it's returned to you.

The interest portion is generally taxable.

For example, a hypothetical $5,000 monthly payment might consist of $3,500 of principal and $1,500 of taxable interest.

The actual taxable amount depends on your contract and applicable tax rules.

Can You Fund an Immediate Annuity With Another Annuity?

Potentially, yes.

If you already own an annuity and want to move the funds into an Immediate Annuity, the transaction may qualify as a 1035 exchange.

Section 1035 of the Internal Revenue Code allows certain qualifying exchanges from one annuity contract to another without recognizing the gain as taxable income at the time of the exchange.

The transfer needs to be structured correctly.

Taking possession of the money yourself and then attempting to redeposit it isn't the same as completing a proper direct 1035 exchange.

How Does the Funding Process Work?

Once you've determined that an Immediate Annuity fits your goals, the process generally looks like this:

1. Determine the appropriate payout structure.
2. Compare contractual income guarantees from multiple carriers.
3. Select the carrier and lock in the applicable quote.
4. Complete the annuity application.
5. Establish the appropriate account at the insurance company.
6. Coordinate the transfer of funds.
7. Review the issued policy.

The money goes from the existing account or funding source to the insurance company issuing the annuity.

The Money Doesn't Go to the Agent

When you purchase an annuity through a licensed agent, the premium itself goes to the insurance company.

The agent doesn't take possession of your annuity premium.

Fixed annuity commissions are generally paid by the insurance company and built into the product rather than separately deducted from the premium as an upfront sales charge.

Understanding where your money is going should be part of any annuity purchase.

Choose the Payout Structure Before Funding

Funding shouldn't happen until the contract is structured appropriately.

For lifetime income, determine whether you need:

• single-life income
• joint-life income
• beneficiary protection
• a period-certain guarantee
• another available payout structure

These choices affect the contractual payment.

A joint-life payout, for example, may provide income for as long as either covered person is alive.

Can Your Family Receive the Remaining Money?

A common misconception is that the insurance company automatically keeps your money if you die shortly after purchasing an Immediate Annuity.

That doesn't have to be the case.

An Immediate Annuity can be structured with beneficiary protections so that remaining contractual value can pass to your beneficiaries.

Adding those protections can affect the income amount, so compare the available payout structures before making a decision.

Which Account Should You Use?

There's no universally best account type for funding an Immediate Annuity.

The appropriate source depends on:

• where your assets are held
• your tax situation
• your desired income amount
• your other retirement income
• your liquidity needs
• your estate planning goals

The fact that you can use a particular account doesn't necessarily mean that account is the best funding source for your situation.

Compare Income Before Moving the Money

Immediate Annuities are commodity products.

Before transferring any money, compare the contractual payouts available from multiple insurance companies.

For the same premium, age, payout structure, and income start date, carriers can offer different guaranteed payments.

The comparison should focus on the actual contractual income you're purchasing.

Where to Compare Immediate Annuities

Use our annuity calculators to compare current Immediate Annuity income guarantees from multiple insurance companies.

You can determine how much income a specific premium may generate or work backward from the amount of monthly income you need to determine approximately how much premium may be required.

The Bottom Line

An Immediate Annuity is funded with a lump-sum premium, but that money can come from several different sources.

Traditional IRAs, Roth IRAs, non-qualified funds, and existing annuities may all potentially be used depending on your situation and how the transfer is structured.

The funding itself comes after the more important decisions: determining whether you need an Immediate Annuity, choosing the appropriate payout structure, deciding which account to use, and comparing the contractual income available from competing carriers.

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