This Often-Overlooked Way to Fund Your Roth IRA Has Many Advantages
A Roth annuity can create tax-free lifetime income during retirement or reduce your risk while saving for retirement.
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A Roth IRA is a uniquely powerful retirement savings tool, because you won’t pay taxes on the money you withdraw during retirement. An annuity is a way of generating guaranteed income. Put them together, and you have a powerful retirement protection tool that can provide guaranteed income for life, with a big plus: It’s completely tax-free.
Anyone may roll over part or all of an existing Roth to a Roth annuity. You may transfer all or part of the funds in an ordinary Roth to a Roth annuity. While there are income and contribution limits for new money going into a Roth IRA, they don’t apply to rollovers — including rollovers to a Roth annuity.
Different types of annuities accomplish different things and have distinct pros and cons — like the Swiss army knife of personal finance. Since they’re so varied, one type or another can work well for a Roth IRA. Investment choices, fees and contract provisions vary, so work with an annuity agent who will educate you about your choices and clearly lay out the pros and cons.
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What kind of annuity works for a Roth? It depends on which stage of your financial life you’re in. In the accumulation stage, you’re building wealth for retirement. In your decumulation stage, you’re retired and receiving income from your savings.
Here’s how Roth annuities can work in each stage.
Building wealth for those approaching retirement
One attractive option is a fixed indexed annuity. With the stock market continuing to break records, it may be vulnerable to a major long-term downturn. When you’re young, you can ride out the ups and downs. But if you’re in your 50s or 60s, you may want to get growth potential without taking the risk of losing Roth money you’ll need during retirement. If so, an indexed annuity might be a good choice for you.
It pays interest based on an underlying market index, such as the S&P 500 or the Dow Jones Industrial Average. While the interest earnings are locked in, up to a stated cap (you may not get all of the upside) each year, you’ll never lose money when the index declines.
While indexed annuities are linked to one or more underlying market indexes, their value does not vary from day to day. Instead, they pay a varying amount of interest that is credited and locked in each year on the anniversary date of the contract. Since equity markets can be volatile, indexed annuities are designed to be held long-term, whether yoked to a Roth IRA or not.
A fixed-rate annuity — also called a multi-year guarantee annuity, or MYGA — is a more conservative choice. It works like a bank CD, paying a set interest rate for a set period. Fixed-rate annuities these days pay much more than CDs of the same term. As of April 2021, you can earn up to 2.90% a year on a five-year fixed-rate annuity and up to 2.25% on a three-year contract, according to AnnuityAdvantage’s online rate database. The top rate for a five-year CD is 1.25% and 1.05% for a three-year CD, according to Bankrate.
Fixed-rate annuities can play a key role in asset allocation. Let’s say you decide to split your Roth assets up 50-50 between equities and fixed income. A fixed-rate annuity can give you a much higher rate of interest than you’d get today with safe fixed-income alternatives, such as CDs and Treasury bonds.
For current annuity rates, see this online annuity database (opens in new tab). Interest is paid and compounded annually.
How to get tax-free lifetime income during retirement
Other than a traditional employer pension or Social Security, an income annuity is about the only vehicle that can guarantee an income for as long as you live. And by combining an income annuity with a Roth, that income is tax-free.
If you need income from your Roth very soon, consider an immediate income annuity. You can open a Roth annuity with a single payment (such as a tax-free rollover from an existing Roth IRA) to an insurance company. The insurer in turn guarantees you a stream of income. You can choose how long the payments will last — for instance, 15 years. Most people, however, choose lifetime payments as “longevity insurance.”
You can receive your first monthly income payment a month after your annuity contract is issued.
If you’re married, consider the joint-income option. With it, your spouse will receive regular monthly income payments for the remainder of his or her life too. Payments to a surviving spouse are always tax-free.
If you don’t need income right now, consider a deferred income annuity. Here, your income stream will begin at a future date you choose. By deferring payments, you let the insurer credit more interest over the years on your behalf, and you’ll ultimately get more monthly income. For instance, by delaying lifetime annuity payments from age 65 to 75, you’ll get about 85% to 90% more each month. On the other hand, you and/or your spouse won’t receive the deferred payments as long.
Another option is an indexed annuity with an income rider. The rider guarantees a certain income regardless of the performance of the annuity. It provides income like a deferred income annuity, plus the potential upside of an indexed annuity. It’s sometimes called a “hybrid” annuity.
The downside is cost. The rider typically costs about 1% of the annuity value annually. The insurer deducts this amount from your policy.
The advantage is retaining your money. Unlike an income annuity, which typically has no cash surrender value, an indexed annuity with an income rider lets you keep your money while guaranteeing lifetime income, starting on a date you choose. You thus have flexibility. If you need the money, it will be there for you to withdraw or annuitize. (Wait until the surrender period is over to avoid any penalties.) If you don’t need the money, you can pass on any remaining value to your heirs.
Is the extra cost worth it? It all depends on your situation and goals and your desire to leave money to your heirs.
Whether you’re saving for future retirement or are currently retired or soon will be, annuities offer a range of often-overlooked strategies for the Roth IRA and amplify its advantage of tax-free retirement income.
A free quote comparison service with interest rates from dozens of insurers is available at https://www.annuityadvantage.com (opens in new tab) or by calling (800) 239-0356.
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
Retirement-income expert Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed and immediate-income annuities. Interest rates from dozens of insurers are constantly updated on its website. He launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities. More information is available from the Medford, Oregon, based company at https://www.annuityadvantage.com (opens in new tab) or (800) 239-0356.
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