retirement

Avoid tax by rolling IRA into an annuity?

George SaenzDear Tax Talk,
I believe the interest portion of an immediate annuity distribution is taxed as ordinary income and the principal portion is tax-free. The entire distribution (after age 59 1/2) from a traditional individual retirement account is taxed as ordinary income. May I use the balance of a savings incentive match plan for employees, or SIMPLE, IRA (for example, $200,000) to acquire an immediate single premium annuity by rolling the IRA into the annuity and thus avoid ordinary income tax treatment on the IRA distribution and pay only ordinary income tax on the interest portion of the annuity distributions?
-- Barton

Dear Barton,
You have the taxation of an annuity correct. What you're missing is how the annuity was acquired. Buying an annuity with after-tax dollars versus pretax dollars in an IRA changes the taxation of the principal return.

An annuity is a contract you purchase usually from an insurance company that will provide you with periodic payments. Those payments consist of an interest element and principal return, which is the amount that was paid for the annuity. Think of it as a reverse loan: You lent the insurer money, and they are paying you back periodically.

An immediate annuity means that you start to receive the payments immediately after purchasing the contract. In a deferred annuity, the amount paid continues to be invested by the insurer until such time as you choose to receive payments.

An IRA can be invested in an annuity contract. In fact, an IRA is similar to an annuity in that the owner of the IRA can take periodic payments from the IRA. This is kind of the concept of the required minimum distribution.

Although you can roll an IRA into an annuity contract, the source of the capital invested in the contract is still pretax dollars. Hence, the payment of the principal to you will always be taxable.

Ask the adviser

To ask a question on Tax Talk, go to the "Ask the Experts" page and select "Taxes" as the topic. Read more Tax Talk columns.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

Bankrate's content, including the guidance of its advice-and-expert columns and this website, is intended only to assist you with financial decisions. The content is broad in scope and does not consider your personal financial situation. Bankrate recommends that you seek the advice of advisers who are fully aware of your individual circumstances before making any final decisions or implementing any financial strategy. Please remember that your use of this website is governed by Bankrate's Terms of Use.

advertisement

Show Bankrate's community sharing policy
          Connect with us
advertisement
CD & INVESTING NEWSLETTER

Learn the latest trends that will help grow your portfolio, plus tips on investing strategies. Delivered weekly.

Blog

Jennie Phipps

Social Security disability tactics

If you must claim Social Security Disability Insurance, or SSDI, here are some things you need to know.  ... Read more

advertisement
Partner Center
advertisement

Connect with us