Monday, June 15, 2009

There's an Annuity in my IRA!

[Welcome Wall Street Journal readers!]
One of our commenters raised an issue about which we've never written: the use of annuities in IRA's. As I replied to said commenter, there are some very good reasons to own an annuity inside an IRA wrapper (and, of course, some very good reasons not to).
First, let's review some basics. An IRA (Individual Retirement Account) is a financial tool which allows one to accrue retirement funds on a tax-advantaged basis. There are two forms of IRA: "Traditional" and "Roth." The first allows one to deduct contributions from one's income tax, but the interest earned will eventually become taxable at retirement. Contributions to the Roth version aren't deductible, but the interest isn't taxable come retirement time.
Annuities are risk management tools, used to minimize market risk. Because they're insurance products, they also offer some unique benefits (such as annuitization, which can provide a guaranteed lifetime income stream) and guaranteed interest (growth).
Annuities also have their own tax advantages which closely mirror those found in IRA's, which begs the question: isn't an annuity inside an IRA something direct from the Department of Redundancy Department?
Well, yes and no:
IRA's can comprise mutual funds, stocks, bonds, and the like. They can even include annuities. If the only investment vehicles are those with built-in market risk (e.g. mutual finds, stocks, bonds, etc), it's possible to actually lose money inside the IRA (just ask pretty much anyone who's had one over the past year or so). Annuities have built-in guarantees, which can mitigate some of the market risk of the investments.
Some might argue that putting an annuity inside an IRA is simply a way to line a lucky insurance agent's pockets. Of course, that presupposes (wrongly) that no one makes money selling the investments (which also often have "trails"). I'm not a big fan of "one size fits all," so I never recommend that folks use only annuities for retirement savings, but as we've seen, they're terrific risk mitigation tools, and certainly have a place at the IRA table.
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