Purchasing a Fixed, Deferred Annuity in an IRA Can Help You Manage RMDs in Retirement

fixed, deferred annuity

“Should I buy an IRA annuity?” A lot of financial professionals with give you the same answer to that question: “No, it’s redundant.” Some financial planners will advise you never to do this because it’s redundant, but there are times when it might be beneficial, especially when it comes to managing your required minimum distributions (RMD) later on. Before you write off purchasing an annuity in an IRA, you should consider how it could impact you for the life of your IRA.

How Annuities and IRAs Are Similar

Annuities and IRAs offer similar tax benefits, which is why many think it’s redundant to purchase an annuity within an IRA. IRAs aren’t investments. Instead, they are qualified retirement accounts that hold financial vehicles. Using them, you can purchase investments or insurance products and enjoy a number of tax benefits on these products.

Any financial vehicle within the IRA receives the advantage of tax deferral until withdrawal or RMD age. This is why they’re used to hold accounts that don’t have that same tax beneficial status on their own. For example, a mutual fund by itself doesn’t qualify as a tax-deferred retirement product. By purchasing it with an IRA, it’s allowed to use that account’s tax preferential status and become part of a qualified retirement account.

An annuity that’s purchased with pre-tax dollars, on the other hand, is considered to be qualified on its own. It doesn’t need to be in an IRA to take advantage of that tax-deferred status because purchasing an annuity within a retirement plan that provides tax deferral under sections of the Internal Revenue Code results in no additional benefits. While most think that it doesn’t hurt to put a qualified annuity into an IRA, they’d also say that it doesn’t offer any benefit either. It’s also important to keep in mind that the annuity should only be used to fund a qualified plan based upon the annuity’s features other than tax deferral. With that being said, the truth is, there can be a good reason to do this, but it’s often overlooked because it doesn’t pay off until withdrawal.

Using an Annuity within an IRA to Manage Your RMDs

When you turn 70½, whether you need it or not, you’ll have to start taking RMDs from your IRA. The IRS doesn’t care how you allocate assets within the account to do this, as long as you withdraw and pay tax on the required amount by April of the year after you turn 70½ and by December 31 every year thereafter.1

Here is where the problem comes in. Say you have a mutual fund in that IRA, and it’s performing extremely well. At RMD time, you realize that you have to take funds out of that mutual fund. The last thing you may want to do is to withdraw money from that mutual fund during times of peak performance, but with RMDs, you don’t have a choice.

If you have a fixed, deferred annuity in that IRA, you can schedule it to start making income payments as of your RMD start date. Assuming the amount of the income payment from the annuity is enough to satisfy the minimum RMD you are required to take, this allows you to decide where the RMD comes from – which means you could keep your high-performing funds in the IRA for longer. At some point, if you live long enough, most or all of your assets within the IRA may need to be liquidated to meet your RMD requirements but you retain the right to choose in which order to liquidate your assets.

The cost for not taking your RMDs is extremely high and can cause you to incur fees of up to 50% of the amount you were supposed to withdraw. Accidentally missing this withdrawal by the required date could take a big chunk out of your nest egg, which is why it’s best to plan for it in advance. A fixed annuity within an IRA allows you to create a future payment that can help address those RMDs without having to reallocate assets when it comes time to take them. While this offers a clear benefit for buying a fixed index annuity within an IRA, there are times when you can’t or shouldn’t place an annuity into one and all annuity features, risks, limitations and costs should be considered prior to purchasing an annuity within a tax-qualified retirement plan.

When You Should Consider Keeping Your Annuity Separate

If you have an annuity with a death benefit, it will have a listed beneficiary. If you have an IRA, you likely have a beneficiary listed on that account as well. If those two beneficiaries aren’t the same, it will complicate matters for those who are named beneficiaries.

In addition, buying an annuity within an IRA doesn’t negate that annuity’s underlying fees. Every financial product has fees, in addition to fees the IRA will charge. If the fees are relatively high in your annuity, then you should consider whether or not this is a good idea.

Finally, if you inherit an annuity, and you’re a non-spousal beneficiary, you can’t put it in your IRA. Instead, if you want to include it within an IRA, it must go into a special IRA in the decedent’s name to benefit you. If you inherit an annuity from a spouse, you are permitted to put it in your IRA.

There are some good reasons for purchasing fixed annuities within your IRA, especially for managing your RMDs. If you’re interested in using this strategy, please consult with one of the insurance professionals in Retirement HQ’s network for more information.

By contacting RetirementHQ, you may be offered information regarding the purchase of insurance products. All of our financial professionals are licensed insurance agents. Additionally, some individuals may also be registered with a broker/dealer or as an investment adviser. Our financial professionals do not offer estate planning, tax or legal advice. Always consult with a qualified advisor concerning your own situation.

Show 1 footnote

  1. “Retirement Topics – Required Minimum Distributions (RMD),” Irs.gov, The Internal Revenue Service, accessed May 27, 2016.