The financial advisory industry is taking sides on the topic of annuities inside IRAs, but investors should understand why. First, let’s define an annuity and an Individual Retirement Account (IRA).
What is an annuity? The IRS defines an annuity as an insurance contract requiring regular payments for more than one full year to the annuitant (owner). Annuities are sold by agents with state-issued life insurance licenses and provide a death benefit upon the passing of the owner (not always guaranteed). Some annuities are variable or indexed to the stock market.
What is an Individual Retirement Account? An IRA is a type of savings account designed to help you save for retirement. It can also be used as a vessel to hold old retirement plan assets, like a 401(k). IRAs offer numerous tax advantages, mainly tax-deferral of income until retirement or in the case of a Roth IRA, tax-free growth.
Why are so many annuities in IRAs today? Insurance salesmen know that IRA’s are where a majority of American’s hard earned dollars sit and some push this product on unknowing investors. Traditional IRAs, 401(k) and a 403(b) plans are examples of a tax-sheltered vehicle, funded with pre-tax dollars. In an IRA, taxes on these dollars, along with growth, are already deferred until withdrawals are necessary. It makes little sense to have a tax-sheltered product inside of a tax-sheltered retirement vehicle.
Insurance agents tend to sell more annuities when markets are volatile, usually in times when a 3% guarantee sounds good. However, the market doesn’t stay down for long. Investors will immediately find that missing out on the long run market upside is far more destructive to their wealth than any annuity benefits they might receive.
The fear of losing principal is just that; fear. Variable annuity products cannot shield your assets from loss. Unfortunately, a death benefit can’t help you while you are alive. With additional fees for variable annuities compared to an IRA holding common stock for example, an investor is much better off investing directly in an IRA. For more information, speak to your trusted fiduciary advisor.