Over the years, we have seen what we deem as tragic situations when it comes to holding annuities in an IRA. For example, imagine a 55-year-old investor with an IRA of nearly $500,000 invested in three variable annuities "for diversification." Additionally, these products had income riders, which brought the average expense on these annuities to 3.9 percent. These fees in addition to any custodial fees he paid for the IRA ate into the growth of his investment over time. With those hefty fees coming out of his investment, it was no surprise that this investor could never match what the market was doing.
While an annuity contract has the unique ability to provide an infinite payout distribution over someone's lifetime based upon a finite premium deposit, investors end up trading higher fees and often less-than-market returns for the guaranteed income. In certain circumstances, investors with a limited amount of money can transfer the risk of outliving their money to the insurance company. However, it is situations like the above that warranted a closer look by the government. As it stands now, the Department of Labor's new fiduciary rule, which investment advisers must comply with by April 2017, is designed to address those who would sell an annuity that is not in the best interest of the client.
However, a new type of annuity was put in place by the government in 2014 because so many retirees were upset with the required minimum distribution rules that forced investors to begin withdrawals at age 70½. The Treasury Department regulations "created" a Qualifying Longevity Annuity Contract.
This provision that allows an investor to put up to 25 percent of his total IRA balance as of the previous year, not including Roth IRAs, with a limit cap of $125,000 into a Deferred Income Annuity with payments starting no later than age 85. At age 70½, the investor would take his RMD based on the balance of his IRA, not including the annuity, thus deferring the withdrawal and the income tax on $125,000 until much later. At age 71, based on the Uniform Lifetime Table, an investor's RMD on an IRA balance of $500,000 would be around $18,900. If the investor put $125,000 into a Qualified Longevity Annuity Contract, his RMD would be based on an IRA balance of $375,000, making his mandatory withdrawal around $14,200.
The emphasis with these annuities is the guaranteed income stream. To be considered a qualifying longevity annuity, the annuity must be a fixed annuity and cannot have a cash surrender value. However, the annuity contract can include a "return of premium" rider, so should the annuitant die, the beneficiaries could receive an amount equal to the premium paid, less any amount that has been paid out as income payments.
Annuities are not appropriate for all investors, but Qualified Longevity Annuity Contracts can work in particular cases. Before you buy an annuity product, you should consult a financial adviser who is not selling the annuity product to evaluate your situation. As long as the deferred annuity meets very specific requirements, the value of the annuity deposit will no longer be included in the value of your IRA for required minimum distribution calculations.
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