Annuities in IRAs?

Occasionally the question comes up about whether it makes sense to buy a variable annuity inside a tax-deferred plan like an IRA. Please refer to the list of four features provided by annuities that appears at the top of this article.

The first, income deferral, is utterly irrelevant if the annuity is held in an IRA or retirement account. The IRA and plan already provides for the deferral and, in fact, distributions are governed by the provisions of Section 72 applicable to IRA retirement plans, not the general annuity provisions. I would go so far as to tell anyone who has someone trying to sell them one of these products in a plan based on the tax benefits to run as fast as possible away from that adviser. S/he is either very misinformed or very dishonest.

The second, beneficiary designation, is also a nonissue for annuities in a retirement account. IRAs and qualified plans already provide for beneficiary designations outside of probate, for better or worse.

The third, annuitization, is potentially valid, since that is one method to convert the IRA or plan balance to an income stream. Of course, nothing prevents you from simply purchasing an annuity at the time you desire the payout rather than buying a product today that gives you the option in the future.

I suppose it is possible that the options in the product you buy today may be superior to those that you expect would be available on the open market at the time you would decide to "lock it in" or you may at least feel more comfortable having some of these provisions locked in.

Finally, the fourth feature involves the actual guarantees that are provided in the annuity contract. To take care of an obvious point first: the guarantees are provided by the insurance carrier, so clearly it's not the level of FDIC insurance that is backed by the US Government. But, then again, only deposits in banks are backed by this guarantee, and the annuity guarantees have generally been good when called upon.

Normally, any guarantee comes at some cost (well, at least if the insurer plans to stay in business [grin]) and the cost should be expected to rise as the guarantee becomes more likely to be invoked. Some annuities are structured to be low cost, and tend to provide a bare minimum of guarantees. These products are set up this way to essentially, provide the insurance "wrapper" to give the tax deferral.

I would note that if, in fact, the guarantees are highly unlikely to be triggered and/or would only be triggered in cases where the holder doesn't care, then any cost is likely "excessive" when the guarantee no longer buys tax deferral, as would be the case if held in a qualified plan. Note that the "doesn't care" case may be true if the guarantee only comes into play at the death of the account holder, but the holder is primarily interested in the investment to fund consumption during retirement.

What this means is that you need a) a full and complete understanding of exactly what promise has been made to you by the guarantees in the contract and b) a full understanding of the costs and fees involved, so that you can make a rational decision about whether the guarantees are worth the amount you are paying for them.

It's theoretically possible to find a guarantee that would fit a client's circumstance at a cost the client would deem resaonable that would make the annuity a "good fit" in a retirement plan. Some problems that arise are when clients are led to believe that somehow the annuity in the retirement plan gives them a "better" tax deferral or somehow creates a situation where they "avoid probate" on the plan. A good agent is going to specifically discuss the annuitization and investment guarantee features when considering an annuity in a plan or IRA and will explicitly note that the first two (tax deferral and beneficiary designation) don't apply because it's in the plan or IRA.