With over 10,000 baby boomers reaching retirement age every single day, many of these retiring workers are asking questions like “Can I move my 401k without penalty?” and “Should I transfer my 401k to an annuity.” Both are questions that involve a 401k rollover strategy.
The first question is an easy one. You can move your 401k without penalty by transferring it to an IRA. This is also a non-taxable event. The second question is a little trickier. You can transfer your 401k to an annuity. The real question is should you? Let’s take a look at why you should or shouldn’t transfer that 401k asset to an annuity.
Transferring your 401k to a personal IRA (Individual Retirement Account) is a non-taxable event. The money transfers from one institution to another under 401k transfer rules, and that transfer is tax free (exempt from federal tax and state tax) to your rollover IRA. That’s the nuts and bolts on how to administratively get it done.
The bigger question is what are you trying to achieve. I always ask 2 questions to determine if you need to consider an annuity.
I bolded CONTRACTUAL for a reason. Annuities are contracts issued by life insurance companies and primarily solve for lifetime income or principal protection. If you don’t need to accomplish either or both of those two solutions, then you do not need an annuity.
In my opinion, if you are still looking for market type growth after transferring your 401k assets, then do not buy an annuity. Regardless of what any agent or advisor will tell you, annuity types that promote market growth have limitations on the upside. If you want real market growth, then go get it. Annuities just won’t be the vehicle to get you there.
Rolling over your 401k to an IRA (i.e. Traditional IRA structure) can be a transition from growth to income. Most 401k plan investment choices are mutual funds geared toward market growth during your working years. For the demographic tidal wave of workers transitioning to retirement, the vast majority are looking for lifetime income guarantees for them and their family. That’s where annuities can be a perfect fit.
Annuities offer one benefit that no other financial products offer. That monopoly is lifetime income. There’s no ROI (Return on Investment) until you die because you can never outlive the payments.
If you need income to start as soon as possible, consider transferring some or all of your 401k to a Single Premium Immediate Annuity (SPIA). If you need income to start at a future date, you should consider a Deferred Income Annuity (DIA), Qualified Longevity Annuity Contract (QLAC), or an Income Rider guarantee attached to a deferred annuity. All can be set up “Joint Life” with your spouse/partner, and all of these annuity types can be structured so that any unused money will go 100% to your listed beneficiaries on the policy.
Whether you decide to transfer your previous employer or employer’s plan (i.e. transfer 401k to IRA) comes down to one question. Do you want to continue to shoulder the risk of volatile markets or do you want to transfer that risk?
If you want to continue to strive for market growth, then you don’t need an annuity. If you want to fully protect the principal or guarantee a lifetime income stream, then an annuity transfer of risk contract might be suitable and appropriate for your specific situation.
For example, if you just wanted to protect the principal from market loss and not pay any fees, you might choose a Multi-Year Guarantee Annuity (MYGA). This is the annuity industry’s version of a CD (Certificate of Deposit), and a simple and efficient choice for contractually guaranteed annual yield.
In the past with your employer’s 401k plan, the only investment options you had were most likely mutual funds. The hope was to have your money grow with the stock market over time. In most cases, you were the one having to choose the funds. If you wanted a lifetime income stream, you had to transfer your 401k money to an guaranteed payment annuity. However, there is a new income game in town.
In December of 2019, The Secure Act was passed that allows 401k type plans to offer a good option for future lifetime income needs...using annuity strategies. This will allow plan participants to allocate some or all of their 401k contribution to an annuity strategy that will guarantee lifetime income starting at a future date of your choice. This could be a total game changer once the majority of 401k plans start offering annuity income options to their workers. In combination with Social Security benefits, then 401k Annuities will offer another income stream that you can never outlive.
For most people nearing or actually in retirement, a big part of your investment focus and retirement plan is establishing what I call the “income floor.” The income floor is the guaranteed income stream that will hit your bank account every month regardless of what happens in politics, the stock market, or the world in general. That income floor money is coming in like clockwork and can originate from your retirement savings or retirement accounts. Social Security payments, RMDs (Required Minimum Distributions) from your Traditional IRA, pension payments (if so lucky), and annuity guarantees are some examples of your potential income floor.
An important side note about annuities, some states have laws where annuities are protected from creditors. In addition, some annuity types offer tax advantages (non-Roth IRA) with their income guarantees. Another item you need to be aware of is if you are less than 59 ½ years old when you retire or decide to transfer your 401k account, there will be early withdrawal penalties (IRS rules). Rolling that money to an IRA or an annuity makes sense in order to avoid those penalties.
Just a word of advice, never ask the majority of agents or advisors if you should transfer your 401k to an annuity. Take a guess what that answer will be. The theme from the movie “Jaws” comes to mind!
If lifetime income, principal protection, and transferring risk are items that you want to contractually guarantee, then annuities might be the right move. If not, then transfer your 401k assets to an IRA and manage the money. The decision is that simple.