Annuities can be purchased inside an IRA, but is an IRA the right home for an annuity? The debate has raged for years and the answer depends on which advisor you talk to.
But considering the fact that as many as one-half of variable annuities sales are made in an IRA rollover, the question is key for all annuity producers. The answer turns on whether the producer can sufficiently separate and identify the tax and non-tax client objectives that justify selling a tax deferred product to a tax exempt plan.
No Double Deferral
There’s no such thing as double tax deferral, leading to the biggest client complaint of all about purchasing an annuity in a tax deferred account such as an IRA: An annuity doesn’t offer additional tax deferral when purchased in an IRA, eliminating one of the product’s primary selling points.
Instead, many financial services professionals recommend purchasing investments, such as stocks, that do not otherwise offer tax deferral in a tax deferred account; and if there’s money left over, consider purchasing an annuity outside the account. An investor can sock away only $5,000 a year in an IRA, why “waste” some of the account’s funds by buying an annuity?
If you’re going to sell an annuity into an IRA, tax savings definitely won’t cut it as a justification.
The preceding arguments are based on the assumption that annuities are purchased only for their tax deferral benefits. But annuities offer benefits beyond just tax deferral. If an annuity is a better option than other safer investments in an IRA, there’s no inherent reason not to purchase an annuity in an IRA.
Why are you recommending that your client purchase an annuity in their IRA?
Annuities offer features that other “safe” investments do not. Annuities can include guarantee riders—such as death benefits, guaranteed crediting rates and guaranteed withdrawal benefits—that may motivate a client to make the purchase. Many retirees are still spooked by memories of waking up during the recent financial crisis to find that their retirement accounts had dropped as much as one-third in value. These risk adverse individuals may find that annuities offer them the security they crave. As long as they aren’t making the purchase for tax-deferral purposes, why not make the right purchase regardless of where it will be held?
Have you documented the non-tax reasons for recommending the purchase?
Many advisors counsel their clients against purchasing an annuity in their IRA because of the expenses associated with annuities. This reasoning is not related as much to the interface between annuities and IRAs, but is more a general criticism of annuities as an investment product. The argument goes, “Why purchase an annuity in your IRA when you can get a better return from another investment product with lower fees?”
As written by contributor David Sterling earlier this year, “Will a Cessna satisfy your needs when you are looking for a sailboat?” The primary appeal of annuities is usually their contribution to retirement security and income sufficiency, not unlimited upside or total return. If a client’s primary concern is income sufficiency, and an annuity is the best product to get them that security, does it matter where the annuity sits?