Annuities in Qualified Retirement Plans

By Russell Hill

Using annuities in qualified retirement plans.

Qualified annuities reduce your current taxable salary in addition to accumulating tax deferred earnings, when you contribute money to an annuities program through an employer (as one of the investment options in a salary reduction retirement plan).

Those who work for nonprofit organizations, will probably be able to choose either fixed annuities or variable annuities, or both, within their employer's retirement plan. In addition, some companies have added annuities to their menu of salary savings opportunities.

Those who own a small business, or work for themselves, can invest in a qualified annuity by setting up a Simplified Employee Pension (SEP). A number of financial institutions, including banks, insurance companies and mutual fund companies, have generic plans that can be adopted. We have access to several generic plans and our financial specialists can provide assistance in getting them established.

Many qualified retirement plans are self-directed. In other words, the participant can choose where to put their money from the alternatives the employer offers. The contributions can be invested in any combination of the available portfolios, generally allocating on a percentage basis. For example, in a qualified annuities program that has a combination of variable annuities and fixed annuities, one might put 50% of their contribution into an equity investment portfolio, 25% into another equity portfolio, and 25% into a money market or fixed income account. In most plans the money can be reallocated among investments at least once a year. When a transfer is made there isn't any income tax on the gains, but there may be fees for some switches. It is important to note that the underlying investment portfolios of variable annuities are subject to market risk.

Annuities in an Individual Retirement Account (IRA)

You can usually buy fixed annuities or variable annuities within your existing IRA. Many experts point out that the death benefit provision (which guarantees that if you die while still saving for retirement, your beneficiaries will receive at least the amount of your principal and in some cases, with the purchase of optional riders, which carry additional fees, that amount plus locked-in investment gains), as well as the potentially strong performance of variable annuities, can make them a smart choice.

If you want to buy annuities with your IRA contribution, you can select a contract that allows you to invest the amount annually that complies with IRS rules. When you're ready, but no later than age 70½, the annuity can be easily converted to an income stream which you can't outlive.

It is important to note that investing in variable annuities in an IRA (or other qualified plan) does not provide any additional tax deferred treatment of earnings beyond that provided by the IRA itself. You are adding a layer of additional fees to your IRA, which could make it harder to achieve the same return as you might otherwise earn--assuming that you allocated your money in similar ways. On the other hand, some of those fees go to pay for the insurance features, as well as the additional fees and costs of the contract, which many people think are valuable. You should consider these insurance features, and whether or not the annuity gives you a broader range of investment choices, when you consider funding an IRA or other qualified plan with fixed annuities or variable annuities.

How About a Roth IRA?

Roth IRAs are appealing investments, if you qualify to use them. Though they resemble non-qualified annuities - you invest with after-tax dollars and your earnings grow tax deferred - there is a major difference. After you reach age 59½ and your account has been open for five years, you can make tax free annuity withdrawals from the Roth. At the top of the tax scale, that can mean having $40,000 more on $100,000 in accumulated savings than you would if taxes were due.

Remember, not everyone is eligible to use a Roth IRA. Your contribution is limited to the annual IRA cap. There are also income limitations--you must have taxable compensation and your modified adjusted gross income must be less than $110,000 ($160,000 if you are married and file a joint return).

Individual Retirement Annuities (IRAs)

In this case, IRA stands for Individual Retirement Annuities rather than Individual Retirement Account. An IRA can also be established with an annuity provider and build an annuity-based plan There is the same limitations to the annual investment cap that applies to all IRAs (except rollovers), and there is the same requirement to begin withdrawing at age 70½ . The Internal Revenue Service sets specific restrictions regarding Individual Retirement Annuities which are not met by all annuity products.

The contribution cap for Individual Retirement Annuities was $3,000 for 2002 through 2004. It increased to $4,000 for 2005 through 2007, and reaches $5,000 in 2008. Since year 2002, for those who are age 50 or older, there has been a provision to make annual catch-up contributions each year.

A tax deduction for the contribution amount might be available for those who aren't eligible for an employer-sponsored retirement plan or for those whose income is less than the current ceiling for deductibility. However, be sure to consult with your tax advisor and financial planner, before setting up the plan.