Tax Implications for When IRA Is Converted to an Annuity?
Converting your individual retirement account to an annuity can make it easier to budget in retirement. An annuity turns your savings into a fixed series of payments so your future income is more predictable. There are no extra taxes for changing your IRA into an annuity as long as you keep the annuity contract active. Canceling your annuity creates a number of extra taxes and fees, so don't make this conversion until you are sure it's the right choice.
Converting your IRA into an annuity should not have any tax effect. The annuity also counts as a retirement account, so transferring your money doesn't count as a withdrawal. You just need to make sure the money gets in the annuity on time. If you make a direct transfer between accounts, you won't have any problems. If the IRA company deposits your money in your bank account first, you need to transfer it to your annuity within 60 days. Otherwise, it will count as a withdrawal, and the entire amount will be taxed.
Your annuity will continue to invest and grow your savings. If you purchase a fixed annuity, you will see a fixed and guaranteed rate of return on your account. If you invest in a variable annuity, your annual return will depend on the investments in your account. Either way, the IRS doesn't tax your annuity earnings as long as they stay in your account. Just like your IRA, the annuity delays taxation until you receive the money as a withdrawal.
When you receive a payment from your annuity, the entire payment is taxed as income. Since you never paid income tax on your IRA contributions and earnings, you owe those taxes when you receive your annuity payment. You also owe tax on the annuity earnings. You pay the same amount of tax on your IRA money whether you take it out of an annuity or straight out of the IRA in retirement. There is no extra penalty or fee for using an annuity as a payout tool.
If you need to cancel your annuity, it starts to get expensive. When you cancel your annuity to get a lump-sum payout, the entire payout is taxable at that time. If you are younger than 59 1/2, you will owe an extra 10 percent penalty on the entire amount. On top of taxes, you also could owe extra money to the annuity company. Annuity companies usually charge a surrender fee on their products when they are canceled within the first five to seven years.
David Rodeck has been writing professionally since 2011. He specializes in insurance, investment management and retirement planning for various websites. He graduated with a Bachelor of Science in economics from McGill University.