Can Annuities Be Changed to an IRA Without Tax Penalty?

Either IRAs or annuities can give you the retirement you want if they're used wisely.

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Annuities can be a useful part of your investment portfolio, providing tax-sheltered growth for your capital. Unfortunately, they're rather quirky because of their roots in the life insurance industry. If you have a portion of your investment nest egg in annuities, and you'd like to make better -- or at least different -- use of it, you might want to roll your annuity into an IRA. Sometimes that's possible, but more often, it's not.

Qualified vs. Non-Qualified

Most annuities work like a Roth IRA. You make your contributions in after-tax dollars, so you don't get a deduction in the year you contribute. On the up side, you won't get taxed on those dollars when you start taking distributions from the plan. "Qualified" annuities are held inside a plan such as a 401(k) or 403(b), which qualify for a tax deduction. It's not an intuitive choice because your annuity capital is already sheltered from taxation, but some employers' plans offer annuities as an investment option. If your annuity is in a qualified plan, you'll be able to change it into an IRA. Otherwise, you'll have a date with the IRS.

Transfers and Rollovers

The simplest method of shifting money from a qualified annuity to an IRA is through a transfer. You just have to notify the companies holding your IRA and your annuity, and fill out the necessary paperwork. Your money moves seamlessly from one to the other without you ever having any legal responsibility for it. If you opt for a rollover, the annuity company will issue you a check or electronic payment for the full value of your annuity. You'll have 60 days to deposit the funds into your IRA without penalty. Otherwise, it'll be treated as a fully taxable distribution, just like funds from a non-qualified annuity.

Non-Qualified Annuity

Non-qualified annuities are the kind most people own, and it can be expensive to get your money out. The amount you've invested isn't taxed a second time because you paid your premiums in after-tax dollars. Your gains, on the other hand, are fully taxable as ordinary income. If you haven't reached the age of 59 1/2 when you cash out or "surrender" your annuity, you'll pay an extra 10 percent penalty on the taxable portion. If you've only owned your annuity for a few years, you might also be liable for surrender fees. Of course, your IRA contribution limits are still a factor, so you might pay all those penalties and still not be able to contribute the funds to your IRA.


In that case, you have a few alternatives. For example, your money might be in a stodgy fixed-rate annuity, and you'd rather seek high returns from equity investments. In that case, most annuity companies will let you transfer your funds to a variable annuity. Variable annuities invest in mutual funds and other equity vehicles, so you can chase bigger returns without incurring a tax penalty. If your current annuity company's costs are too high or the conditions are too restrictive, you can take advantage of a 1035 exchange to transfer the funds to another company's annuity product. Be careful to investigate the new annuity closely, so you don't find yourself in a similar situation a few years later.