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SmartAsset: Converting an IRA to an Annuity

Generally, people who convert their individual retirement accounts (IRAs) to annuities are near retirement. They’re worried about outliving their money. Or maybe they’re trying to protect their nest egg from a future bear market – or worse. If this describes you, an annuity that offers a consistent stream of income for life may be right for you. There are tradeoffs though. The biggest one: if you start receiving payments but die early, the insurance company will keep your premium unless you paid extra for payouts to last for, say, two lifetimes (yours and a spouse’s). So you’ll want to do your homework before using your IRA to buy an annuity.

A financial advisor who serves your area can help you build a retirement plan for the future.

Pro: Annuities Generate Reliable Income

If you’re worried about running out of money in retirement, an annuity can help allay your fears. In exchange for your premium (or money in your IRA), the insurance company would guarantee steady payments for life (or a set number of years). You can start these payments right away or within a year if you get an immediate annuity – or have your money grow before you start payments if you get a deferred annuity.

If a steady stream of checks sounds good to you, experts often recommend getting an annuity to cover your fixed monthly expenses. That way, you may not need to hand over all of your nest egg to the insurance company.

Certainly, the regular cash flow from an annuity can make it easier to manage your finances in retirement. You’ll get a set amount every month (or quarter or year), so you don’t have to worry about drawing down your nest egg when the stock market is volatile. There’s also the promise that you will receive payments as long as you live, no matter how long that is. You may prefer this protection if you’re a conservative investor.

Con: You May Not Get to Use All Your Money

SmartAsset: Converting an IRA to an Annuity

One of the main drawbacks of converting an IRA to an annuity is that once you start receiving payments, you can’t pull the money back out. Even if you become very sick and know that you won’t live as long as you expected, you can’t cancel the contract. Should you die prematurely, your nest egg will stay with the insurance company – and not go to your heirs. That’s the chance the insurance company took when it sold you the annuity. (You, of course, took the opposite chance that you would receive more in payments than you put in.)

Of course, you can pay extra for riders that provide for your spouse or beneficiaries. For example, you could get an annuity with survivor benefits, where payments will continue for a set period of time or the survivor can choose to receive a lump sum. Or you could get a joint annuity that covers both lives of a married couple, or a joint annuity with survivor benefits. These riders, though, are expensive and will likely lower the amount you receive as your regular payments.

That said, if you buy a deferred annuity and haven’t annuitized yet, you can get your cash back. But you’ll pay steep fees to the insurance company, plus a 10% penalty to the IRS if you aren’t 59.5 years old yet. In the event that you die before you annuitize, most annuities will return your premium minus any withdrawals and fees to your beneficiary.

Pro: Annuities Don’t Require You to Be Hands-On

One of the nice things about converting an IRA to an annuity is that you really don’t have to do anything other than collect a check afterwards. You don’t have to worry about rebalancing your portfolio or tracking returns because the payments you’re receiving are exact. That can be appealing to investors who favor a passive approach.

Con: Passivity Comes at a Cost

SmartAsset: Converting an IRA to an Annuity

Of course, the privilege of not spending a lot of time managing annuity investments comes with a price tag. Brokers or insurance agents will charge a commission. If it’s indirect, it’ll be part of the calculation of your payouts. If it’s direct, it’s often calculated as a percentage of assets involved. So if you’re converting $250,000 in assets and there’s a 10% fee, that’s $25,000 that goes straight into the broker’s pocket.

Annuities often come with annual fees as well. These fees are for managing the annuity and are similar to the administrative fees you’d pay for a mutual fund in an IRA. The difference, however, is that you could end up paying more fees through an annuity.

Bottom Line

At first glance, annuities seem like a great deal. Who wouldn’t want a guaranteed stream of income for life? But if you look closer, you’ll see the tradeoffs. You’re locking in your money, you’ll pay steep fees and your heirs may never see any of your nest egg. There’s also the fact that an annuity is an agreement with an insurance company. So its guarantees are only as good as the company’s financial strength.

Tips for Retirement Planning

  • Planning for retirement can be a complex venture, but a financial advisor can help. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • It’s never too early to start planning for retirement. A retirement calculator can help you figure out how much you’ll need to retire comfortably. Building a sizable nest egg may enable you to delay Social Security benefits. This will allow you to maximize your monthly payments once you are ready to collect.

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Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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