By Orlando McCall
As you probably know, a 401(k) is a tax-deferred retirement account you can either get through an employer or on your own.
You contribute money to the account in employer-sponsored plans, usually via a regular deduction from your paycheck. With a traditional 401k plan, your taxes on earnings are deferred until you take distributions. If you have a Roth 401(k), you pay taxes as you invest.
If you have one of these retirement plans and are nearing retirement age, your advisor may have discussed “rolling over” the money in your account into an annuity to create an income stream. A rollover can be an excellent choice for some people, provided the rollover is done correctly, according to IRS rules.
Why should you consider a rollover, anyway?
If you contribute to a 401k, 403b, or any other kind of qualified plan, you usually do so because of the ability of your investment to grow tax-free. You may have chosen a Roth IRA because you believe, like many of us, that taxes are bound to increase, so it’s better to pay the IRS now rather than later.
Regardless of your plan, however, tax advantages are a primary reason Americans put money into qualified plans in the first place. In most instances, directly rolling over plan funds into an annuity is not a taxable event. This means you can continue growing your wealth tax-free until you take distributions. However, you will want to ensure you know all the nuances, rules, and regulations and seek advice.
In addition to tax advantages, there are some other reasons you may want to discuss rolling your qualified plan into an annuity with your retirement income specialist.
You create a kind of “retirement insurance.”
Rolling an IRA or other qualified plan into an annuity gives you some insurance on your investment. Like most people, you wouldn’t dream of driving your new car around town without adequate insurance. Nor would your lender finance your largest asset, your home, without insurance in place. Amazingly, though, many people never consider purchasing insurance for their retirement plans. Not having insurance on your retirement savings plans leaves them vulnerable to risk in the form of market fluctuations and poor decisions by fund managers.
By rolling over a portion of your retirement savings into a specifically-designed annuity contract, you convert those savings into a stream of predictable, guaranteed income that you won’t outlive. This income stream functions as insurance against erosive forces outside your control that tend to eat away at your nest egg.
You would like income and inflation protection. If you rolled your qualified plan into a variable or immediate annuity, your income stream is based on a pre-determined, guaranteed rate. This rate remains the same, even if the market goes down. As we continue to have a turbulent, post-pandemic market, many retirees are shocked to see their plan balances are too low for them to retire comfortably. An annuity can offset plan losses and make it easier to retire, even in a bear market.
What are some things to think about before rolling over your plan?
While there may be many upsides to doing a rollover, you must also understand some potential issues.
Surrender fees are penalties you pay if you want or need to withdraw your money early. Some annuities, including many variable annuities, may have signficicant surrender fees built into the contract. When reviewing rollover options, be sure your annuity specialist thoroughly explains any surrender or other fees.
You may decide that the additional features you want to add are not worth the extra cost. Also, there may be charges for some “annuity riders” you select. Always ask your agent for a breakdown of these charges and how they will impact your account.
Finally, I encourage you to remember that it is an irrevocable decision if you choose to roll your IRA or 401k into an immediate annuity. You relinquish your right to access the principal in exchange for gaining a guaranteed lifetime income.
Summing it up: For some seniors, a rollover from their company plan makes a lot of sense. Those seeking protection of their principal investment, income for life, or to leave a legacy to their family may benefit from an annuity. However, deciding to roll over requires careful attention to detail, strict adherence to IRS rules, and a deep understanding of the qualified plan and the chosen annuity contract. It is not something you should undertake on your own. Always get assistance from a qualified retirement income planner who specializes in annuities.
