If you own a variable annuity issued by an insurance company you may be thinking that you’d rather roll over its value into an IRA—to give you more control over your investment. Annuities are particularly complex investment vehicles. You may well need a financial advisor or accountant to help you figure out what makes sense.
But before you get that far, understand the issues. Here’s what you need to know to determine whether rolling over your variable annuity is a good idea—or even possible—and how to do it.
How a Variable Annuity Works
An annuity is an insurance product that can help you save for retirement by letting your investment in it grow on a tax-deferred basis until it is paid out to you. Annuity investments have the unique trait of letting you convert their value into a stream of guaranteed income to run over a period of years or the rest of your life. A variable annuity enables you to choose its investments from a menu of options such as stocks, bonds and money market funds, while a fixed annuity earns a set interest rate.
Tax-wise, variable annuities and Traditional IRAs are similar. Each provides investment returns that are not taxed until distributed—and before age 59½, distributions from each are subject to a 10 percent early-withdrawal penalty. So moving funds from a variable annuity to an IRA doesn’t provide any big tax advantage on that score. But there are differences that matter. What are they?
Pros and Cons of a Rollover
An IRA provides much more control over your investment than does a variable annuity. You can put IRA funds in almost any legitimate investment you want, while options under a variable annuity contract will be limited. You also can withdraw IRA funds whenever you wish (although you will generally pay an early-withdrawal penalty before 59½), while withdrawal options under an annuity contract will be restricted and perhaps subject to “surrender charges.” Variable annuities also often have higher annual costs and fees than do IRAs and the investments available through them (such as low-cost index mutual funds and ETFs, or exchange traded funds).
With an IRA, you can also consolidate the value of several annuities in a single account. Many people come to own multiple variable annuities over their working careers through various employers’ retirement plans, such as the 403(b) plans of governmental and nonprofit organizations, and 401(k) plans. Keeping funds in one IRA instead of several variable annuities can make managing them easier.
Variable annuities offer some advantages, too. They aren’t subject to the restrictive contribution limits that apply to IRAs, or to mandatory withdrawals beginning at age 70½—although many investment advisors consider these reasons to invest in annuities only after IRA contributions have been maxed out. Also, there may be simplicity and security in having an insurance company manage retirement savings. Having full control over IRA funds means having full responsibility for them; you must be able to avoid the costly mistakes of making bad investments and unwise early withdrawals.
Can You Even Make a Rollover?
After considering all the above, say you decide you want to roll over your variable annuity into an IRA. Can you?
The answer depends on whether the variable annuity is tax “qualified.” IRAs can receive tax-free rollovers only from employer-sponsored qualified retirement plans and other IRAs. If you have a 403(b) account, for instance, its value can be rolled over into an IRA, as can a variable annuity held in a 401(k) or in another IRA. But if you bought your annuity directly on your own, outside a qualified plan, no rollover is possible.
Of course, you can move funds from a nonqualified annuity into an IRA through a taxable transaction. You must terminate the annuity, pay any tax and early-distribution penalty due, then contribute the net after-tax proceeds to the IRA, subject to the annual IRA contribution limit ($5,500, or $6,500 if you’re 50 or older).
By contrast, you can make a tax-free rollover of a qualified annuity into an IRA in any amount. The safest and easiest way to make one is by a direct trustee-to-trustee transfer, with the funds sent directly into your IRA. Alternatively, you can receive a distribution from your annuity by check, and deposit it in your IRA within 60 days. But 20 percent tax withholding will apply to the distribution, and if you miss the 60-day deadline it will be fully taxable.
Even though rollovers are tax-free they may still be subject to fees and surrender charges imposed by the annuity contract. These typically are largest when an annuity was recently purchased. Check your contract’s terms—even if you can make a tax-free rollover you may wish to postpone doing so until these charges diminish or expire.
A variable annuity can be attractive when the day comes that you need guaranteed income, but before then it is relatively inflexible (you may not be able to change investments without a charge, for instance). For greater flexibility, consider the pros and cons of rolling over an annuity into a Traditional IRA, if you can.
And if you’re thinking of buying a new annuity, pay particular attention to its contract restrictions. Also check whether the annuity has “qualified” status to ensure flexibility in case you want to reinvest it in the future.