Can an Annuity Be a Smart Choice in an IRA?

By Ken Nuss

Is it a good idea to buy an annuity within an IRA or Roth IRA? At first blush, the answer would seem to be “no” because one of the biggest benefits of an annuity is tax deferral, which you already have in an IRA.

But it’s not so simple. “The answer is, ‘It depends”. It depends on, your age, risk tolerance, desired asset allocation, and many other factors. For many investors, it makes perfect sense to use an annuity in an IRA.”

One factor is your life expectancy. If you’re in good health and have a family history of longevity, lifetime income—which only an annuity can deliver—can be invaluable.

Because an annuity can create a lifetime (or joint lifetime) income that cannot be outlived, there’s a compelling reason to consider one, especially when you start taking money out of your IRA. There is no other way to guarantee that your income will last as long as you do.

Different Annuities Have Features That Can Be Valuable in an IRA

Fixed annuities guarantee your principal. They’re designed for people who want to wake up each morning knowing that they have more money than when they went to bed the night before for at least part of their money.

Fixed annuities come in many types. Choosing the type that is suited to meet your goals is also important. One type even offers growth potential along with guarantees.

Any pre-retiree or retiree should consider annuities for part of their IRA portfolio.

A multi-year guaranteed annuity (MYGA) is much like a certificate of deposit, guaranteeing an interest rate for a set period. Because interest is credited annually and reinvested in the annuity and taxation is deferred until interest withdrawals begin, it’s called a deferred annuity. Most MYGAs pay somewhat higher rates than CDs with a comparable term.

Most people need a bond component in their IRA portfolio. Fixed-rate annuities can be an excellent substitute for bonds. They typically offer a guaranteed rate of interest for three to ten years—a period that can be matched to your time horizon. Bond funds, in contrast, don’t offer a guaranteed rate of return. If rates spike, you can lose money.

They’re great for savers who want or need a guaranteed interest rate for some of their money.

An immediate annuity, in contrast, pays income immediately. If you’re over 70½, it also helps fulfill your required minimum distributions (RMDs). It’s a great way to get a guaranteed lifetime income,

An immediate annuity converts an asset to income efficiently, but in return you have little or no ability to change the income stream once it starts. Some retirees don’t like the idea of illiquidity, But it is very hard to obtain the same level of guaranteed lifetime income any other way.”

In contrast, a deferred income annuity (DIA), also called a longevity annuity, is a type of fixed annuity with a deferred income starting date. It provides guaranteed lifetime, or joint lifetime, income after an initial holding period of anywhere from two years to as much as 40 years.

The main advantage of a DIA is that usually the income payout will be significantly higher than with an immediate annuity. The insurer rewards you for making a long-term commitment and deferring your payout.

 A qualified longevity annuity contract (QLAC) is a recent variation on the DIA. It’s designed to meet specific IRS requirements so that you don’t need to make RMDs on the assets in the QLAC contract. It’s the only way you can legally delay RMDs for a portion of your IRA funds and thus keep more money in your IRA longer.

A fixed index annuity uniquely provides both growth potential and guaranteed principal protection. Immune to stock-market downturns, it offers a share of the gains when the market goes up. In exchange for a guarantee that you’ll never lose any principal, you’ll typically get only part of the market’s gains—as measured by an index such as the Dow Jones Industrial Average or S&P 500—as an interest credit. Interest is credited when the index value increases, but when it falls, you lose nothing.

The index annuity is suited for IRA investors who want principal protection but are willing to withstand some interest-rate uncertainty. You get an opportunity to earn more interest than you can get from a fixed-rate annuity or a bank CD. You can shelter some of your money from market risk without locking in a lower interest rate.

Optional guaranteed lifetime-income and/or withdrawal-benefit riders are commonly available for an additional fee.

Unlike fixed annuities, variable annuities do not guarantee principal. While variables offer greater growth potential than fixed annuities, their fees usually make them unsuited for IRAs except under special circumstances. Variable annuities work best in taxable accounts where tax deferral is a major advantage.

Ken Nuss is the Founder and CEO of AnnuityAdvantage. Ken entered the financial services industry in 1986 and obtained a Series 7 securities license in 1992, becoming an investment representative with a full-service brokerage firm. In 1999, he launched the AnnuityAdvantage website to help people looking for their best options in principal protected annuities. Today, AnnuityAdvantage is a leading online provider of fixed-rate, fixed-indexed and immediate income annuities.