The main advantage of using an income annuity in your IRA is to create guaranteed lifetime income, without risk. Billions of IRA dollars are used each year to purchase annuities. The key is making sure to own the right annuity.
The main objective of an IRA is to use pre-tax dollars to create future income later in life. Distribution amounts are pre-determined by IRS guidelines. Since the regulations do not require that distributions are guaranteed or paid for life, that responsibility falls on the retiree. Even as most people prefer guaranteed lifetime income, it is not what is actually happening within their IRA. To the surprise of many, they own equities offering no guarantees or lifetime income.
More is better both in terms of the guarantees and lifetime income payments.
A Simple Comparison.
Let’s assume there are two people, each 71, with two identical IRAs worth $500,000 and each person must begin taking minimum distributions (RMD). Everything about these two IRAs is the same except for how the $500,000 is invested. Traditional IRA #1 is made up of nothing but equities. IRA #2 owns an income annuity paying MORE THAN 5% FOR LIFE, IT CAN NEVER LOSE PRINCIPAL and EVERYTHING IS GUARANTEED.
Which IRA should you have?
Number #2, with the income annuity, is the better choice because it provides guaranteed payments for life without any risk. The traditional IRA would have to average more than 5% annually to compete. Some critics argue that the annuity’s inherent tax deferred status is wasted inside an IRA. This is not so. It is a red-herring designed to confuse people. The tax deferral is not being “wasted” when the IRA’s primary objective is to create retirement income for as long as possible.
The extra risk you assume in a traditional IRA is simply not worth it. If one of the primary goals in retirement is to preserve principal, then equities in IRAs offers little upside. One of the main risks we face in retirement is outliving our assets, or longevity risk. Running out of distributions in 20 years or less is entirely possible when the principal is invested in equities. When IRAs suffer principal losses in negative return years, the chance of running out of principal accelerates. In order to get a sufficient amount of interest, many people take too much risk. The impact of this low interest rate environment can be a tough pill to swallow for retirees.
To mitigate the risk of losing principal, IRA assets are sometimes invested in blue chip equities, bonds, CDs and other low yielding assets. In those cases, an income annuity will offer a better rate of return, better principal preservation and guaranteed income for life. That’s a tough combination to beat.
Nothing creates guaranteed lifetime income like an annuity. In a brief conversation, I can help you assess whether or not this strategy might add security and peace of mind to your retirement without any cost or risk.
There has been a long-standing rule of thumb about combining annuities and IRAs. The thinking was quite similar to the municipal bond rule in IRAs that suggests you never purchase them inside of an IRA, because the tax deferral is wasted in an already tax-deferred account.
But, this belief has been rendered outdated due to significant improvements in income annuities. The proper indexed annuities are widely accepted for their income riders, their guaranteed living benefit riders, enhanced death benefits, innovative investment features and their outright superior fixed income yields. Economists and professors at Harvard, Wharton, Duke, Yale, UCLA and the University of Chicago are in alignment about these advantages. The advantages are undisputed.
Says Michael Kitces, investment planning expert: “Given these changes, it is perhaps time to abolish the ‘annuities should never go into an IRA’ rule and recognize that it has become more a myth and remnant of old than proper advice in today’s environment.”
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