Tax Free annuities are entirely possible with some planning and knowledge about Roth conversions.
One of the biggest negatives continually re-hashed about annuities is that just like IRAs they are taxed at ordinary income tax rates on earnings. So why not avoid tax all together with a Roth Annuity! Oh, did I mention that when the IRA is converted to a Roth the tax must be paid in full in the next tax year. However, if you think taxes are likely to go up it may make a lot of sense to get the tax paid now when it is lower.
Dick and Eric discuss the many ways to use annuities that are tax free or tax advantaged in this short video.
**Guarantees, including optional benefits, are backed by the claims-paying ability of the issuer, and may contain limitations, including surrender charges, which may affect policy values. During this segment, Dick and Eric are referring to Fixed Annuities unless otherwise specified.
Want more Roth & Annuity information? Kelly Greene of the Wall Street Journal authored two articles that look at the impact of Roth conversions.
Annuity Payments Using a Roth IRA Are Tax-Free
As long as you meet the holding and age requirements for a Roth individual retirement account, your annuity payments should be tax-free.
Many retirees are considering immediate fixed annuities these days. Generally, you hand over a large chunk of money to an insurer, which issues you a monthly check for life. The appeal in a recession is that annuity payments could soften hits suffered by your other investments. (The main drawbacks: Once you hand over your money to the insurer, you generally can’t get it back. And your fixed payments might not keep up with inflation.)
As Roth accounts increase in size, using them to buy plain-vanilla annuities might make sense for a portion of conservative retirees’ nest eggs, said Jeffrey Landers, an investment adviser with Wachovia Securities in New York.
A Roth annuity could assuage two of the three top concerns his retired clients have, he said: outliving their income and future tax increases. He suggests addressing the other big retirement worry, inflation, by using 25% to 30% of a nest egg to buy an annuity covering basic expenses, and continuing to invest the rest in a diversified way.
Or, if you are willing to accept a slightly smaller annuity payout, you could buy an annuity with annual raises.
Of course, if you purchase an annuity, payments usually end with your death. Thus, if you use a Roth IRA to buy an annuity, your heirs might not get to enjoy one of its best features — a tax-free inheritance.
To hedge your bets, you could buy an annuity with your Roth that **guarantees payouts for a set time period, such as 10 years. [Read More…]
Why It May Pay To Convert to a Roth IRA
Investors and financial advisers are preparing to take advantage of a new tax law that makes it easier to gain access to Roth IRAs—even if it means breaking a sacrosanct rule about Roth conversions.
Starting, Jan. 1, the $100,000 income limit disappears for converting traditional individual retirement accounts and employer-sponsored retirement plans to Roth IRAs, one of the biggest changes on the IRA landscape in years. Roths, of course, have long been viewed as one of the best deals in retirement planning; after investors meet holding requirements, virtually all withdrawals are tax-free. [Read More…]
Annuity Guys® Video Transcript:
Eric: Today, we are talking about tax-free annuities.
Dick: Better get them while they last, Eric.
Eric: They are in limited supply. When their shelves are empty, they are all gone.
Dick: That is right.
Eric: You better act quickly.
Dick: How about that? Tax-free annuities; isn’t that the opposite of what we’re told? Stereotypically, annuities are taxed at ordinary income tax rates, just like IRAs.
Eric: You know what the CPAs are calling right now, “They are wrong. The tax-free annuity doesn’t exist.”
Dick: Our phone’s going to be blowing up.
Eric: They’ll tell you it doesn’t exist. I have not seen anyone advertise for a tax-free Annuity.
Dick: Here we have a limited supply.
Eric: That is right; we’ve got them in short supply. Dick, you got to tell us, how does one get one of these limited supply annuities?
Dick: Here we go. What we have is no different than what you have, and that is you have your traditional IRA, that IRA can be converted to a Roth, of course, you will have to pay your tax the following year.
Eric: They are not tax-free then.
Dick: You have to pay the tax in the IRA.
Eric: It’s the first, okay.
Dick: Folks, once that you’ve actually converted to the Roth, you can then put that money into an annuity. That annuity becomes fully tax-free. It can give you a tax-free income for the rest of your life; it can pass tax-free to your heirs. It can actually become a retirement account for your heirs. There’s some intricacies to that, which we can talk about. The idea of using a Roth strategy in an annuity is not that well-known, it’s not talked about that often, and it can be a great advantage.
Eric: We say limited supply; why do you say limited supply? We’ve Roth’s for how long? There’s been a recent change though, it used to be there was an income threshold out there.
Dick: In 2010 they wiped it out. If you make over $100,000, it doesn’t matter, you can convert. Limited supply, we’re having a little fun with this, folks, like an annuity sale. The limited supply really comes down to Uncle Sam giveth . . .
Eric: And Uncle Sam taketh away. When someone’s looking for tax dollars . . .
Dick: Our government needs money.
Eric: If you believe taxes are going up, raise your hand. If that is the case, is better to then . . .
Dick: It is likely that Roth could be an endangered species.
Eric: Roth will turn to Moth.
Dick: It could.
Eric: It is going to mothballs very soon.
Dick: Getting poetic.
Eric: Yes, I am trying to rhyme.
Dick: If we’re in this situation where taxes were likely to rise, the government is looking for revenue, the Roth advantage benefit could be closed, tightened up. What we really experienced in the past Eric, with various insurance products and tax advantages, as long as they were entered into legally and under IRS and government-type sanctions, then usually, there was a guy in there who grand fathered in. It’s the new folks coming in that were somewhat penalized.
Eric: usually, they won’t go back and try to take it away from you, usually. Right now we believe that if people get it in before the government decides that this money is too tempting, we’ve got to reach in there and get [inaudible: 03:46].
Dick: We can just let these people this tax-free advantage.
Eric: Or their kids or their grandkids.
Dick: That’s where we go into it is potentially limited supply. Folks, this is something you genuinely want to consider, you want to use an advisor that really understands the Roth-IRA, the tax advantages, and the ways to incorporate that into annuity. Eric, I’d like to point out another thing while I’m thinking about it here; there’s different ways to convert an annuity to a Roth-IRA. We could use an existing annuity that’s an IRA.
Eric: You are saying if I own an annuity that has an IRA wrapper with it already . . .
Dick: You can convert it.
Eric: I don’t have to convert the annuity? I don’t have to go get a new annuity?
Dick: You do not. You can actually convert that annuity in to a Roth. Even better, in some situations where you’re doing proper planning and you know in advance that you’re going to be converting this, you may want to go ahead and convert your Roth inside your present account then transfer the Roth into an annuity, if that was the purpose or the reasoning; pick up that 10% bonus, tax-free, 8% bonus, or whatever you get with the annuity. Again, as maybe you have an income rider. I’m getting too much here.
Eric: I just got a tax-free bonus.
Dick: It is just the whole package of being tax-free, and the fact that if you put an income rider on it, that you’re going to have potentially tax-free income. Even if your account value goes to 0 because you have lived a long, long life, your income will just continue tax-free.
Eric: Obviously, there are standard benefits of the Roth that you don’t have to worry about RMDs; the transfer of wealth tax-free. In many ways, it [inaudible: 05:44] life insurance. One thing that I was looking at earlier was the Social Security Tax aspect. The reason that comes into play, even with annuities with IRA wrapper, a lot of times you are going to take those RMDs that are going to kick that Social Security income level to a level that’s taxable.
Dick: It really can push it up in to that taxable.
Eric: If that is one of the things you can potentially avoid by converting it into a Roth, there’s even sometimes that it’s . . . usually, the rule of thumb used to be you want to be able to pay for that conversion, those taxes basically, out-of-pocket. You don’t want to reduce your balance.
Dick: Exactly.
Eric: Some of the formulas that we’ve looked at actually said, “You can save more on the backend by not having those RMDs force you in to a higher taxable consequence.” Now we’re talking all sorts of fun things.
Dick: I think a lot of it, Eric, gets down to; do we believe taxes are going to go up? If you believe taxes are going up, folks, raise your hands. It’s unanimous, no hold-outs. Most rational folks . . .
Eric: And some irrational.
Dick: . . . believe that taxes have nowhere to go, at least for the next 10 or 20 years, but up. It’s a perfect place to look at Roth and say, “Whether I’m going to use the money or I’m going to pass it to my heirs, I want to protect them from increasing taxes.”
Eric: If nothing else, it needs to be one of the things you consider for your retirement future, is how it will impact. Work with a good advisor, discuss the possibilities, and it should be one of those pieces that’s on the table. Taxes are going up; limited supply.
Dick: That’s right. Get them while they last. Thank you.
Eric: Have a great day.