In every client’s life, there comes a time when simplicity and predictability can become the most sought-after components of a retirement income plan. For many, the shift occurs right around the time that IRA required minimum distribution (RMD) compliance must begin. Fixed income annuities have traditionally provided a simple solution for creating the stability that your clients need, but combining the annuity product with an IRA can magnify the impact by solving the RMD problem in the process. Overcoming the typical objections to housing the fixed income annuity within your client’s IRA by focusing on the benefits of this strategy can be the key that will unlock the door to providing RMD simplicity.
Why Use a Fixed Income Annuity in an IRA?
We all know that annuity contract holders are required to begin taking RMDs from their IRAs after reaching age 70½. What is often overlooked is that fixed income annuities can make compliance nearly automatic. Fixed income annuities held inside a client’s IRA usually comply with the RMD rules automatically because payments are determined in the same way that the RMD itself is calculated, using a formula based on the life expectancy of the client and the amount invested.
Simplifying the RMD process is only part of the reason why a fixed income annuity might be a beneficial addition to your client’s IRA. While a cash RMD is required each year after the client turns 70½ regardless of general market conditions, it is important to remember that your client’s IRA assets may be invested in a variety of holdings, including securities and funds that will fluctuate with the equity markets.
Unfortunately, the RMD requirements may, depending on market performance, cause your clients to miss out on market upswings by requiring clients to liquidate securities held within the IRA in order to satisfy their RMDs. Using a fixed income annuity can help eliminate this risk because the payments are fixed in advance.
In other words, there is no investment decision required each year because the client has already determined the value of the payout (whether it is made monthly, quarterly or annually). While the RMD for any nonannuitized portion of the IRA will still have to be calculated, the value of the annuity is excluded from this calculation, thereby reducing the risk that the client will be forced to make an unfavorable investment decision simply to comply with the RMD rules.
Further, the fixed income annuity actually allows the client to set an income level in advance. RMDs will fluctuate with the IRA value in any given year, but the annuity payments will remain constant regardless of the performance of the remaining underlying IRA assets. Clients today even have the option of adding a cost of living increase to the annuity payouts to ensure sufficient income during retirement.
Potential Objections and Drawback
As with any strategy, there are potential objections and drawbacks that every client should understand. Most commonly, advisors may feel that it makes little sense for some clients (especially younger clients) to hold an annuity within their IRAs because both types of investments are tax deferred, so the annuity could be held separately from IRA assets with similar consequences. As a result, some might feel that the strategy is simply redundant.
Additionally, amounts held in an annuity are more difficult to access than other IRA funds without incurring significant penalty charges. If the client has a financial emergency after age 70½, he could access nonannuitized IRA funds without penalty. Clients should, therefore, only consider purchasing the annuity with IRA funds if they have sufficient assets held outside of the annuity to cover any unforeseen expenses.
Further, while holding an annuity within an IRA can allow the client to avoid selling IRA assets during unfavorable market swings, it can also mean that the client has no reason to liquidate those holdings when their value is high, potentially avoiding a loss if the value eventually falls.
Holding a fixed income annuity within an IRA is a strategy that can simplify your clients’ financial decisions. While the strategy does not fit into every client’s plan, for those who have reached the age of RMDs, the peace of mind can prove invaluable.
Originally published on National Underwriter Advanced Markets. National Underwriter Advanced Markets is the premier resource for financial planners, wealth managers, and advanced markets professionals who provide clients with expert financial and retirement planning advice.
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