Every day, more than 10,000 baby boomers reach retirement age. Many of these workers are asking themselves questions like “should I transfer my 401(k) to an annuity?” and “can I move my 401(k) without penalty?” â Both are questions that involve a 401k rollover strategy.
The first question is an easy one. Your 401(k) can be moved to an IRA without incurring penalties. This is also a non-taxable event. The second question is a little trickier. You can transfer your 401k to an annuity. The real question is: Should you? Let’s examine the pros and cons of transferring that 401(k) asset to an annuity.
Keywords: 401(k), annuity, retirement, income, fees, risks, benefits, investment
As you approach retirement, you may be wondering whether to move your 401(k) to an annuity. This decision can be complex, with both potential benefits and risks to consider. This guide will help you understand the key factors involved in making this important choice.
What is an annuity?
An annuity is a financial product that provides a stream of income, typically for a set period of time or for the rest of your life. You purchase an annuity with a lump sum of money, and in return, the insurance company guarantees to pay you a regular income stream.
Benefits of moving your 401(k) to an annuity
- Guaranteed income: Annuities offer a guaranteed stream of income, which can provide peace of mind in retirement. This is especially beneficial if you are concerned about outliving your savings.
- Tax advantages: Annuities grow tax-deferred, meaning you don’t pay taxes on the earnings until you withdraw them. This can be a significant advantage over other retirement investments.
- Principal protection: Some annuities offer principal protection, which means that you are guaranteed not to lose your initial investment. This can be a valuable feature for those who are risk-averse.
Risks of moving your 401(k) to an annuity
- Fees: Annuities typically have high fees, which can eat into your returns. These fees can include sales charges, administrative fees, and mortality and expense risk charges.
- Limited investment options: Annuities typically offer a limited range of investment options, which can restrict your ability to grow your money.
- Loss of control: Once you purchase an annuity, you typically cannot access your money without penalty until the end of the contract term. This can be a disadvantage if you need to access your money for an emergency.
Should I move my 401(k) to an annuity?
The decision of whether or not to move your 401(k) to an annuity depends on your individual circumstances and financial goals. Here are some factors to consider:
- Your risk tolerance: If you are risk-averse and want to guarantee a steady stream of income in retirement, an annuity may be a good option for you. However, if you are comfortable with taking on more risk in exchange for the potential for higher returns, you may be better off keeping your money in your 401(k).
- Your financial goals: If your primary goal is to generate income in retirement, an annuity can be a good choice. However, if you have other financial goals, such as leaving a legacy to your heirs or funding a large purchase, you may be better off keeping your money in your 401(k).
- Your age and health: If you are in good health and expect to live a long life, you may benefit from the guaranteed income stream of an annuity. However, if you are in poor health or have a shorter life expectancy, you may be better off keeping your money in your 401(k).
- The fees and charges associated with the annuity: Be sure to carefully compare the fees and charges associated with different annuities before making a decision. High fees can significantly eat into your returns.
Alternatives to moving your 401(k) to an annuity
If you are not sure whether moving your 401(k) to an annuity is the right decision for you, there are a few alternatives to consider:
- Keep your money in your 401(k): This is the simplest option, and it allows you to maintain control over your investments. However, you will not have the guaranteed income stream of an annuity.
- Invest in a Roth IRA: A Roth IRA allows you to withdraw your contributions tax-free in retirement. This can be a good option if you expect your tax rate to be higher in retirement than it is today.
- Invest in a diversified portfolio of stocks, bonds, and other assets: This option gives you the most control over your investments and the potential for higher returns. However, it also comes with more risk.
Moving your 401(k) to an annuity can be a complex decision. By carefully considering your individual circumstances and financial goals, you can make an informed decision that is right for you. If you are unsure whether moving your 401(k) to an annuity is the right decision for you, it is always best to consult with a financial advisor.
Frequently Asked Questions
Q: What is the difference between a fixed annuity and a variable annuity?
A: A fixed annuity guarantees a fixed interest rate, while a variable annuity is tied to the performance of the underlying investments.
Q: Can I withdraw money from my annuity before the end of the contract term?
A: Yes, but you may be subject to surrender charges and tax penalties.
Q: What happens to my annuity if I die before the end of the contract term?
A: The death benefit will be paid to your beneficiary.
Additional Resources
Whatâs Your Contractual Goal?
A non-taxable event occurs when you move your 401(k) to an individual retirement account (IRA). The funds are transferred to your rollover IRA tax-free (i.e., not subject to state or federal taxes) from one financial institution to another in accordance with the 401k transfer regulations. That covers the essentials of how to complete it administratively.
The bigger question is what are you trying to achieve. I always ask two questions to find out if you should think about getting an annuity.
- What do you want the money to CONTRACTUALLY do?
- When do you want those CONTRACTUAL guarantees to start?
I bolded CONTRACTUAL for a reason. Annuities are contracts offered by life insurance providers that are mainly used to address issues of principal protection or lifetime income. You do not require an annuity if you are able to complete either or both of those two solutions.
Purchasing an annuity is not advised if, after transferring your 401(k) assets, you are still seeking market-type growth. No matter what an advisor or agent tells you, there are limits to the upside of annuity types that encourage market growth. If you want real market growth, then go get it. Annuities just wonât be the vehicle to get you there.
Rolling over your 401k to an IRA (i. e. Conventional IRA structure) can serve as a bridge between income and growth. The majority of mutual funds offered by 401(k) plans are designed to increase in value over the course of your working years. The great majority of the demographic tidal wave of workers heading into retirement are seeking lifetime income guarantees for themselves and their families. Thatâs where annuities can be a perfect fit.
Annuities offer one benefit that no other financial products offer. That monopoly is lifetime income. Since you can never outlive the payments, there is never a return on investment (ROI) until you pass away.
If you want to start receiving income right away, you might want to think about moving all or part of your 401(k) to a Single Premium Immediate Annuity (SPIA). Consider a Qualified Longevity Annuity Contract (QLAC), an Income Rider guarantee attached to a deferred annuity, or a Deferred Income Annuity (DIA) if you need income to begin at a later time. Everything can be set up in a joint life account with your spouse or partner, and all of these annuity types can be structured so that any unused funds will go to your designated beneficiaries as stated in the policy.
Shouldering Risk To Transferring Risk
Whether you choose to transfer the benefits from your former employer or employer-sponsored e. transfer 401k to IRA) comes down to one question. Do you want to transfer the risk of volatile markets, or do you want to continue bearing that risk yourself?
You don’t need an annuity if you want to keep aiming for market expansion. For your particular situation, an annuity transfer of risk contract may be appropriate if you want to ensure a lifetime income stream or completely protect the principal.
For example, you could select a Multi-Year Guarantee Annuity (MYGA) if all you wanted was to shield the principal from market loss and avoid paying any fees. This is the annuity industry’s equivalent of a Certificate of Deposit (CD), and it’s an easy and effective option for an annual yield that is contractually guaranteed.
When it came to your employer’s 401(k) plan in the past, mutual funds were probably your only option for investments. The idea was for your money to appreciate over time in tandem with the stock market. Most of the time, you had to decide which funds to use. To obtain a perpetual income stream, you were required to move your 401(k) funds to an annuity with guaranteed payments. However, there is a new income game in town.
The Secure Act, which was passed in December 2019, makes 401(k)-style plans a viable choice for meeting future lifetime income needs. using annuity strategies. Participants in the plan will be able to use all or part of their 401(k) contribution to fund an annuity strategy that will ensure lifetime income beginning at a future date of their choosing. When most 401(k) plans begin to provide their employees with options for annuity income, this could be a huge game changer. When combined with Social Security benefits, 401(k) annuities provide an additional source of income that you can never outlive.
Setting up what I refer to as the “income floor” is a major component of your investment strategy and retirement plan for the majority of people who are approaching or have reached retirement. The income floor refers to the monthly income stream that is assured to arrive in your bank account, irrespective of the events in politics, the stock market, or the world at large. That income floor comes straight from your retirement accounts or savings and happens like clockwork. Your possible income floor includes things like Social Security benefits, RMDs (Required Minimum Distributions) from your Traditional IRA, pension payments (if you’re lucky), and annuity guarantees.
An important note regarding annuities: under certain state laws, annuities are shielded from creditors. Furthermore, certain annuity types (non-Roth IRA) provide tax benefits in addition to income guarantees. Another thing to keep in mind is that early withdrawal penalties apply if you decide to transfer your 401(k) account or retire before the age of 59 ½ (IRS rules). To avoid those penalties, it makes sense to roll over that money into an annuity or an IRA.
One piece of advice: don’t ask most agents or advisors whether you should move your 401(k) to an annuity. Take a guess what that answer will be. The theme from the movie âJawsâ comes to mind!.
Annuities may be the best option if you wish to contractually guarantee lifetime income, principal protection, and risk transfer. If not, move the funds from your 401(k) to an IRA and manage them there. The decision is that simple. Share this article: