Converting Roth IRA into an Annuity

(The following is a series of correspondences between Brent and myself. I hope the information can be helpful to a number of people.)

Converting Roth IRA into an Annuity

Hello, I am 52 and planning to retire at age 55 ( I am a federal employee under the older Civil Service Retirement System). My question concerns annuities. A salesman is recommending I convert my Roth IRA to an annuity so there is a guaranteed 5% return (compounded). I could make much more if the investments I choose for the annuity do well – there is a 1% reduction on those excess returns in the form of a company fee. Wouldn’t I incur a penalty by transferring the Roth IRA into the annuity? I’ve never heard of doing this and an internet search didn’t turn up much information. These are funds I don’t plan on spending until much later in life.

Thanks

Brent from Seattle, WA

Answer

Brent, It sounds like you already have a Roth IRA, but since you used the term "convert," I just want to make sure you do not currently have a Traditional IRA, and the salesman is recommending you convert the Traditional IRA to a Roth IRA and then purchase the annuity he is recommending. For purposes of this answer, I will "assume" the former is true and that your IRA is already a Roth IRA. Purchasing a variable annuity with a rider guaranteeing lifetime income is a very good option for someone wanting to guarantee he/she will have a specified amount of income for the rest of their life, especially if you can wait 5 to 10 years to begin the income stream. However, I would like to clarify the terminology you are using as presented to you by the person making the recommendation. These "living benefit" riders come in many forms, such as GMIB(Guaranteed Minimum Income Benefit), GMWB(Guaranteed Minimum Withdrawal Benefit, GMAB(Guaranteed Minimum Accumulation Benefit), and they do add to the expense of the annuity. It is important to understand which Rider your advisor is recommending and the additional cost of the Rider. These Riders are too complicated for me to explain in this response, however, you should ask your Advisor to explain it in detail to you.

In addition, ask your Advisor, to clarify his terminology of guaranteeing you a "5% return," because that can be very misleading, and it sounds like he is proposing a "Guaranteed Minimum Accumulation Benefit." If so, the "5% guaranteed return" would only allow you to elect a lifetime income after a certain number of years utilizing that guarantee, and yes if your investments perform well, you could realize more than the 5% guarantee. The additional cost of these guarantees will, of course, lower your overall return.

As mentioned, these Riders can be complicated and often difficult to understand, therefore I recommend you have the Advisor give you a detailed explanation.

With regard to your question about a penalty, if you currently have a Roth IRA, there would be no IRS penalty for you to put the funds into an annuity if you "roll over" the IRA directly into the annuity.

One last thing I would like to mention, I would hesitate purchasing an annuity from anyone I refer to as a "salesman." An annuity with these types of features should only be purchased through a true "Financial Advisor," who you feel is taking your entire financial situation into consideration, and not looking to merely "sell" you a product.

If any of the above assumptions are incorrect, please let me know and we will look at your situation again.

Best regards,

Jan Jaffin

Converting Roth IRA into an Annuity - reply

Jan,

Thanks for taking the time to answer my question about rolling over the Roth IRA (I have all Roth IRA savings having converted a traditional IRA balance some years ago). Your advice is spot-on, he did rush the decision, I need more information. It is a Xxxxxxx product but he also represents a couple other companies. No mention of a waiting period to lock in the guaranteed return was made. Having bought and cancelled whole life policies in my youth, I am hesitant to make any snap decisions. And I agree a financial advisor with my best interest in mind is the place to go for such a decision.

Brent

Answer

Brent,

I'm glad I could be a bit of help. I don't feel comfortable recommending specific companies or products through this venue, but annuities are my specialty, so feel free to ask any additional questions.

Good luck to you.

Jan Jaffin

Converting Roth IRA into an Annuity - follow up

Jan,

If you have any recommendations on how to find a fee-only financial advisor, I would be most appreciative to receive it. My father was extremely complimentary of your response and we decided this is the way to go for such an important decision and complicated set of products. He started a similar annuity a few years ago and was surprised at how taxes are applied to distributions and really didn’t need the insurance that comes with a VA. So, I think professional independent advice is the way to go.

Brent

Answer

Brent,

You are correct, you do need to seek professional unbiased advice. Trusting your retirement assetts to an individual to invest is an extremely important decision. There are many good Financial Advisors who will work with you to find the best way to invest your retirement funds, both fee-based and commissioned. My recommendation would be to contact some of the better known brokerage firms and banks in your area, and ask to meet with a Retirement Specialist. Then schedule an appointment and interview the Advisor to determine your comfort level with him/her. Ask them how they are compensated, and then make your decision. If they rush to make a recommendation and pressure you to make an immediate decision, that person may only be trying to "sell" you a product. This may take some time and effort on your part, however, it will be worth the effort if you find a person who will work to make sure you have the right retirement vehicle for your particular situation and a person in whom you have complete confidence.

As far as your father's annuity is concerned, it sounds like he has a non-qualified annuity. In a non-qualified annuity, the earnings come out first and of course are taxable at ordinary income tax rates. Your situation is different, if you do not take distributions from your Roth IRA until you have held it for 5 years and you are age 59 1/2, there will be no taxes due when you begin taking distributions. In addition, if you are only interested in income and not a death benefit, be sure to let the person you consult know that you only need a lifetime withdrawal benefit and not any additional death benefit. There are many options available with variable annuities, and your Advisor should only add the one(s) important to you, because each Rider will cost extra and take away from any potential earnings.

Best Regards,

Jan Jaffin