Nearly a year ago, I wrote about holding annuity contracts in your IRA. I mentioned in my nearly 20 years in the financial services industry, I have never seen a time where it pays to have an annuity inside an IRA.
To refresh your memory, an annuity contract has the unique ability to provide an infinite payout distribution over someone’s lifetime based upon a finite premium deposit. Investors with a limited amount of money can transfer the risk of outliving their money to the insurance company. Investors trade higher fees and often less than market returns for the guaranteed income.
A deferred income annuity is a “cousin” of the immediate annuity in that it works about the same, where an investor pays a lump sum to an insurance company now, but instead of immediately generating income, you can defer the guaranteed payments to begin at a specified date in the future.
As of July 1, 2014 the Treasury Department released final regulations that changed the game for certain deferred income annuities. The regulations “created” a new type of annuity—a Qualifying Longevity Annuity Contract. Essentially, certain types of deferred income annuities will receive a new tax benefit. As long as the deferred annuity meets certain requirements, the value of the annuity deposit will no longer be included in the value of your IRA or 401(k) for required minimum distribution (RMD) calculations.
An investor can invest the lesser of 25% of his total IRA balance, not including Roth IRAs, up to $125,000 into a deferred annuity. Payments must start no later than age 85. For example, let’s say a 65-year-old investor with a total IRA balance of $500,000 put $125,000 into a deferred annuity. At age 70 ½, the investor would take his RMD based on the balance of his IRA, not including the annuity, thus deferring the withdrawal and the income tax on $125,000 until much later. At age 71, an investor’s RMD on an IRA balance of $500,000 would be around $18,900. If the investor put $125,000 into a qualified longevity annuity contract, his RMD would be based on an IRA balance of $375,000, making his mandatory withdrawal around $14,200.
To be considered a qualifying longevity annuity, the annuity must be a fixed annuity and cannot have a cash surrender value. The emphasis with these annuities is the guaranteed income stream. However, the annuity contract can include a “return of premium” rider where beneficiaries receive an amount equal to the premium paid, less any amount that has been paid out as income payments.
I maintain that annuities are not the answer for everyone. Those with ample assets should do better investing in stocks, bonds and mutual funds. However, for investors with limited resources who are attracted to the guaranteed income stream an annuity offers and if they have a family history of living into their 90s, this new tax treatment may be worth exploring. Before you buy an annuity product, you should consult a financial adviser who is not selling the annuity product to evaluate your situation.
If you have questions on the use of annuities in your financial plan, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
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