Meet our new "Ask the Experts" adviser on personal finances, Kimberly Foss.
A certified financial planner, she is founder of her own firm, Empyrion Wealth Management in Roseville. This week, she answers a reader's question about investing in an annuity within an IRA.
We are both 81 years old. We both have IRAs ($104,000) and withdraw the required minimum each year. We are losing about $4,000 a year (from the principal) through our minimum withdrawals, which are about 2.4 percent. My question: Is it a good idea to invest in an annuity?
An annuity is one investment option available for your IRA money, as are mutual funds, certificates of deposit and many other types of investments. Although many wealth advisers recommend against holding an annuity within an IRA, if both of you are in good health and your concern is running out of income, an annuity may be appropriate.
There are two primary reasons why you might want to put your IRA dollars into an annuity. First, you can take advantage of annuitization, creating a stream of income that is guaranteed to last a set period of time, perhaps through the remainder of your life. Most annuities come with an income rider that will allow income for life of around 5 percent or your Required Minimum Distribution (RMD), whichever is higher.
Since you are taking a RMD from your IRAs, this would allow you to continue with confidence that, if the account is depleted, the insurance company would continue income payments for one or both of you.
Second, if you put your IRA money into certain variable annuities, you may be able to get a death benefit guarantee. With this guarantee, your beneficiaries are somewhat shielded against market downturns that might lower the value of your investment.
The death benefit guarantee assures that the insurance company will pay (at your death) either the current value or the original principal (minus any withdrawals), whichever is greater. Therefore, your beneficiary can recover your initial investment (minus withdrawals), if you die after a market downturn. If you are uncomfortable with the risk of investing in stock funds, for instance, the death benefit guarantee can reduce your risk.
On the other hand, it is important to understand two strong arguments against putting your IRA money into an annuity.
First, both IRAs and annuities are tax-deferral mechanisms. If you are already deferring taxation by having an IRA, you gain no further tax advantage from investing in an annuity.
Second, with an annuity, you are required to pay an annual mortality and expense fee (generally 1 percent of your investment), along with an annual contract fee. These are on top of any custodial fees that you may be paying for your IRA. Over time, this combination of fees may eat away at the growth of your investment.
Also, there are alternatives to annuities, such as Contingent Deferred Annuities. CDAs essentially guarantee an income stream for your life (or joint lives) in your IRA or other types of accounts and you don't have to move your money into a variable annuity contract. They would provide a 4 percent to 8 percent guaranteed income stream for life, depending on your age.
After explaining some of the pros and cons of annuities, I want to offer a word of caution.
Variable annuities are sold by prospectus. You should carefully consider the investment objectives, risks and expenses before investing. The prospectus, which contains this and other information, can be obtained from the insurance company issuing the variable annuity or from your financial professional. Read the prospectus carefully before you invest.
Compiled by Claudia Buck