Holding an Annuity in an IRA

While annuities differ from IRAs, both financial tools allow your money to grow tax deferred — meaning you won’t pay taxes until you withdraw the money. So, if you’re already getting the tax deferment advantage with the IRA, what is the need for an annuity in the IRA?

To start, the qualifying longevity annuity contract, or QLAC, shifted many opinions on this subject when it was introduced in the 2014 federal tax rules. This rule change allows you to put the lesser of 25 percent of your IRA or 401(k) account or $135,000 into a deferred annuity, also known as a longevity annuity.

In other words, you can put a lump sum into an annuity and receive guaranteed income sometime in the future.

The benefit of holding an annuity inside an IRA is that you no longer have to take required minimum distributions, also known as RMDs, on the money you put into the annuity.

Because of QLACs, holding an annuity within an IRA has become more of a personal decision based on unique financial situations and goals.

“It depends on the needs of the individual investor, coming back to the age of the investor,” Joe Liekweg, an independent agent at Insuractive told Annuity.org.

Required minimum distributions are the lowest amounts the law requires you to withdraw from your IRA once you reach 72 years of age.

Other qualified retirement accounts such as 401(k) plans allow you to delay taking RMDs until you retire if you keep working past 72. But IRAs require you to make a required minimum distribution at 72, whether you retire or not.

If you fail to take out the minimum required amount from your account on time every year, you can face stiff financial penalties. Any money remaining in your account after you die must also be distributed — typically within five years of your death. However, under the SECURE Act,  certain types of beneficiaries of inherited IRAs must take full distribution of the IRA within 10 years of the original owner’s death if the death occurred after 2019.

Because most IRAs defer taxes until you start withdrawing the money from the accounts, the IRS requires you to take out a portion of the funds so they can be taxed. In February 2022, the IRS issued new regulations requiring beneficiaries to to take annual RMD withdrawals for the first nine years and completely deplete their account by December 31 of year 10, provided the beneficiary inherited the account from an owner who was already taking RMDs.

To calculate your RMD, divide your IRA balance by your life expectancy factor as determined by the IRS. You can use the IRS life expectancy tables and worksheets to help with the calculation.

The RMD rules do not apply to Roth IRA owners while they are alive. The money you place into a Roth IRA is already taxed. Since the money you take out is tax-free at that point, the IRS doesn’t require an RMD on Roth IRAs.

Any money you take out of your Roth IRA is tax-free, including money from an annuity inside your Roth IRA. Placing an annuity inside of a Roth IRA can lessen your risk while saving for retirement and generate tax-free lifetime income during retirement.

When deciding whether to place an annuity inside an IRA, consider the goals you are trying to achieve. If you are using your Roth IRA solely for growth strategies, an annuity may not be the best option for aggressive growth. However, if you are looking for safety and peace of mind knowing you will have income for the rest of your life, then an annuity may be right for you.

A longevity annuity is the best type of annuity to hold inside an IRA. A benefit of annuities is that they can be customized to fit your financial needs and goals. Within the category of longevity annuities, you can choose between a fixed annuity and a variable annuity.

Fixed annuities guarantee you a fixed amount of interest on your contributions.

Variable annuities, on the other hand, allow you to choose options in which to invest; the value of a variable annuity fluctuates with the market.

These annuities largely duplicate what you are already doing with your IRA or 401(k) and are meant to be long-term investments.

“A lot of times, if you’re looking to buy an annuity inside of your IRA, that would be your safety portion — like your bond portion — if it’s allowable,” Liekweg said.

It is typically more advantageous to make the maximum allowable contributions to your IRA and 401(k) plans before investing in a variable annuity, according to the Securities and Exchange Commission.