An Annuity In An IRA: Yes or No? Final Comments
If your annuity is in an IRA you must begin withdrawing the minimum required distribution at age 70-1/2 regardless of any surrender charge that may be imposed on the withdrawals.
As always, each investor must weigh the cost-benefit of investment alternatives, including annuities. The question always is, are the features worth the fees? You can pay for special features including specific guarantees. For example, a death benefit may be guaranteed. Variable annuity salespeople often claim that the annuity product is good if you are worried about losing principal by saying that your initial investment is guaranteed. What they don’t point out is the fee you are paying for this guarantee (which is actually a small amount of life insurance), and the fact that the guarantee does you absolutely no good at all. The guarantee only applies if you’re dead. If you die, your beneficiary is guaranteed to receive at least as much as your initial investment.
Annuities are also touted as providing income for life. If you annuitize (and the vast majority of annuities are never annuitized) you can get a specified monthly payment for life. The flip side of guaranteed income for life – meaning that you annuities your contract, agreeing to receive a monthly payment for your lifetime, is that if you die prematurely, your entire remaining account balance is forfeited to the insurance company. It is possible to get a guaranteed term, say life or 10 years whichever is longer, but, of course, there is an additional charge for that.
Some annuities guarantee a minimum rate of return per year (a feature which you pay for). There can be catch – as little as 60% of the invested funds may be eligible for this guaranteed return. The percentage of your investment subject to the guaranteed return is called the participation rate.
In these years of potential market volatility, the idea of a guaranteed return is very appealing to many investors – inside or outside an IRA. However, what is the guaranteed rate of return and how much does this feature cost? A typical guaranteed rate of return could be 4 – 5% per year. Ask how much this additional feature costs and ask what the other costs of the annuity are. How much are you ahead? If this is your primary goal – no principal loss and guaranteed rate of return, compare it to other principal secure options like long-term CD’s and Treasury Bonds. Remember that you have to pay the guaranteed rate option even if your investment inside the annuity out-performs the guaranteed rate, thus reducing your returns.
It is also possible to buy a feature that will guarantee market value over a specific period of time even if the markets lose value. Typically the period is 7 to 10 years. The option may only be available if you annuitize.
As one commentator put it: “variable annuities have more moving parts than a 747.” If they are ever appropriate, it is when they are long-term investments and the investor expects her income tax bracket, when withdrawals are made, to be lower (which is anybody’s guess). Then, one hopes that the tax deferral and tax free accumulation of earnings can overcome the additional costs of the annuity and the annuity’s conversion of capital gain income to ordinary income. For those who have crunched the numbers, this proposition is dubious at best. If you already have tax deferral in an IRA vehicle, there is no way the numbers will put you ahead over the long term when compared to another investment in the IRA.
Have a great week!