Is an Immediate Annuity Income Tax-Free in Roth?
An immediate annuity is an insurance product guaranteeing you an income during retirement. A Roth IRA is a qualified retirement account. "Qualified" means that the account meets certain IRS requirements necessary to receive special tax privileges. When purchasing an immediate annuity inside of a Roth, you should understand how the benefits of a Roth apply to the immediate annuity policy.
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Process
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A Roth IRA only accepts cash contributions on an after-tax basis. This means that any money converted to an immediate annuity inside of a Roth IRA must have been accumulated inside of the Roth prior to the conversion. In other words, you may not make a large, lump sum contribution to a Roth IRA when you retire and then convert your savings to an immediate annuity. When distributions are made, they are made on a tax-free basis as long as they are made after age 59 1/2. Any distributions prior to age 59 1/2 are not subject to this tax benefit.
Significance
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The significance of a Roth IRA is that the immediate annuity inside of the IRA inherits all of the benefits of the Roth account. This means that all of the income generated by the annuity is received on an income tax-free basis. Ordinarily, the immediate annuity would be subject to ordinary income tax to the extent that a gain was realized on the proceeds of the annuity.
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Benefits
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The benefit of an immediate annuity inside of a Roth IRA is that you receive more income than you ordinarily would receive. The annuity also guarantees your income for your entire lifetime or for a set period of time, depending on how you want to receive your annuity payments. In other words, your immediate annuity inside of a Roth account gives you a guaranteed income that is tax-free.
Considerations
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When considering investing in an immediate annuity inside of a Roth, consider that the money used to purchase an immediate annuity must already be inside of the Roth account. Roth IRAs have contributions limits of $5,000 (if you're under age 50) and $6,000 (if you're 50 or over). Because of this, your decision to have a Roth immediate annuity must be part of a long-term plan.
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References
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Comments
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Only a few insurance companies offer a DRA Compliant Immediate Annuity, a product used in Medicaid and VA planning. If a client has a Variable Annuity which contains Roth funds, can it be 1035'd to the insurance company that offers the DRA Compliant Immediate Annuity, and then be annuitized? I assume the answer is true, and all of the funds coming out of the DRA Compliant Roth Immediate Annuity are tax-free. Does anyone disagree? Finally, can a spouse transfer his or her Roth Variable Annuity to his or her spouse without violating any Roth, IRA, or taxation rule or regulation? The assumption is that the unhealthy spouse would make the transfer to the healthy spouse, and the healthy spouse would purchase the DRA Compliant Roth Immediate Annuity.
