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Should I Roll A 401(k) into a Variable Annuity or Fixed Annuity?

August 5, 2019
David Parker, Esq.
Talk to your parents about their estate plan
David Parker, White Plains and New City NY Estate Planning Attorney
David Parker, Esq.
David Parker is an attorney who specializes in Estate Planning and Elder Law and has been practicing law for 30 years. Be it Wills, Trusts, Powers of Attorney, Health Care Proxies, or Medicaid Planning, David provides comprehensive and caring counsel for seniors and their families. A large portion of David’s practice is asset protection strategies so that families do not lose their hard earned savings to nursing home care costs. He also handles probate administration for the settlement of estates.
Many annuities cannot be passed on to a beneficiary; any money left in them when you die goes to the insurance company.

We’d all like to have guaranteed income after retirement, but there are a few risks to think about before you roll a 401(k) into a variable annuity or fixed annuity. There may also be major fees incurred by annuitants, because you risk losing part of your investment if you die prematurely. You may not be able to pass the rest of the annuity on to your beneficiaries.

Investopedia’s recent article asks “What Are the Risks of Rolling My 401(k) Into an Annuity?” The article says many insurance companies advertise the tax benefits of annuities, but a traditional 401(k) is already tax sheltered. A delayed rollover could mean more taxes.

Extra Fees. The big benefit of annuities is that they give you guaranteed income. However, there are some important differences between the income generated by fixed compared to variable annuities. Most annuity investments are made by people looking to ensure that they are provided for in later life. However, you’re likely to see some major expenses if you own an annuity, in addition to your capital investment. The types of fees from your insurance company will vary, depending on the type of investment you select.

Variable annuities usually have higher fees than fixed annuities, because they require a more active, engaged management style. Annuities that protect your principal or guarantee your balance can’t decrease, but have even higher fees. There also may be one-time up-front costs, like a sales commission or a contract fee.

If you decide to withdraw your initial investment early, you’ll be hit with a big surrender charge, starting at 7% and gradually decreasing over the first seven to ten years of account ownership.

Risk of Loss. If you pass away before you use up your 401(k) savings, your named beneficiary will inherit the account. However, if you die before you get the full benefits from your annuity, the insurance company may keep the rest of your savings. Many annuities have the option of having the contract pay over the course of your life and then transfer to your spouse if you die first. Of course, there may be a fee for this. Ask questions and read the fine print.

Tax Trade-Offs. A financial advisor may recommend annuities, because your investment grows tax deferred. That means you pay no income tax on your gains, until they’re withdrawn. However, if your investment capital is already in a traditional 401(k) or IRA account, a rollover to an annuity gives you no additional tax benefits. Earnings on 401(k) funds are already tax deferred, just like your original contributions. As with an annuity, you don’t pay income tax on your contributions or interest until you withdraw those funds after you retire.

Short Time Limits. Another issue to review when rolling over your 401(k) into an annuity, are the tax implications of the rollover itself. While the IRS permits tax-free rollovers from qualified retirement plans, you must complete the transaction within 60 days. Otherwise, you may lose 20% of your balance. Any amount you don’t roll over is taxable as ordinary income, which can substantially increase your tax liability for the year. If you have a direct rollover from trustee to trustee, you can avoid this.

Reference: Investopedia (July 15, 2019) “What Are the Risks of Rolling My 401(k) Into an Annuity?”

Suggested Key Terms: Variable Annuity, Fixed Annuity, 401(k), Retirement, Insurance Company, Tax Deferred

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