How to Rollover an Annuity: An Easy 5 Step Guide

by Rob Phillips, CPA

The purpose of a rollover is preserving an investment’s tax-deferred status. You can structure these within a solo(k) pension plan.

Once you’ve made the commitment to invest for retirement, it’s important to keep the momentum going. Sometimes that means simply continuing to contribute. But there are times when you have to take certain steps to preserve your retirement fund. For example, you might get a distribution from a qualified retirement plan when you change jobs.

Experts agree that you should move the money intact to another qualified plan to protect its tax-deferred status, ensure the opportunity for continued growth and avoid the 10% early withdrawal penalty you might face if you’re younger than 59½ .

Your choices may include a rollover to a new employer’s plan, or to a rollover IRA which may be invested in a variable annuity or fixed annuity or other investments e.g. mutual funds.

 Pluses & Minuses

With any of these choices you preserve the tax-deferred status of your account and let your total assets continue to compound. There are also some additional advantages, and at least one disadvantage to each alternative.

 New Employer’s Plan

 + You begin the new plan with a head start on creating a substantial account

 + Fees on employer plans are often smaller than fees for other accounts

 – You are restricted to investments offered through the plan

 Individual Retirement Account (IRA)

 + You can choose the financial institution that becomes the trustee of your account

 + You can invest your money almost any way you choose, including individual stocks and bonds, mutual funds or a variable or fixed annuity

 – You have to create your own income program

 Individual Retirement Annuity

 + You can select a variable annuity or fixed annuity from a variety of providers, choosing a contract that offers the combination of investment portfolios and rate of return you’re looking for

 + You can take advantage of the broadest range of withdrawal opportunities, including annuitization

 + With a variable annuity, your beneficiaries are guaranteed a death benefit (generally equal to your premium and often earnings less any withdrawals), which have been periodically locked in, if you should die before beginning to take income

 + With a retirement annuity, you can choose to receive an income stream you can’t outlive

 – Your fees may be higher than with other options

 – Not all annuities meet IRS requirements for an Individual Retirement Annuity or a 401(h).

Don’t Mix Your Accounts

You have to be careful to maintain a separate investment account for any retirement funds you roll over. If you deposit rollover money into an existing IRA, you may create confusion about taxes you’ll owe, especially if money already in the account wasn’t tax deductible. Also, be careful with overfunded pensions.

Once the two are combined, you won’t be able to separate them again. This may become important when you begin to withdraw your money.

Do It Directly

If you roll over retirement money directly from one qualified investment to another, it’s a tax-free transaction, and the entire amount goes on growing tax-deferred. But if the payout goes to you first, 20% is automatically withheld, even if you deposit the check immediately in the rollover account.

You’ll eventually get the 20% back as long as you deposit the entire amount of the payout within 60 days. But you’ll have to wait for the refund until you’ve filed your income tax return for the year.

The problem may be coming up with the missing 20% in order to make the full deposit. If you don’t, the tax law treats that amount as a withdrawal, so you’ll owe tax on it and maybe a penalty. What’s more, once you’ve taken a distribution and paid tax on it, that money can never be rolled into another qualified plan. Its tax-deferred status is lost forever.

1035 Exchange

You can exchange one non-qualified annuity for another without owing tax on your earnings by following provisions of Internal Revenue Code section 1035, which is why they’re known as 1035 exchanges.

But if you surrender one annuity and actually receive the money, which you then use to buy another non-qualified annuity, that doesn’t count as an exchange and you’ll be stuck with the tax bill. You can get around that by having the annuity provider assign the contract directly to another provider.

This rule lets you exchange a fixed annuity for a variable, a variable for a fixed annuity, one variable for another, or make a number of other switches. One thing you can’t do is exchange your variable or fixed annuity for a life insurance policy. That’s because at your death, the insurance policy would allow your beneficiaries to avoid taxes on the amount they received—something an annuity won’t let them do.

Before switching investments, carefully consider whether or not exchanging an existing annuity makes sense for you. For example, an exchange may make sense if the new annuity offers features or benefits, which are important to you, that your current annuity doesn’t. On the other hand, going into a new annuity may result in new charges or increase the surrender period. You may also be subject to higher charges, such as annual fees.

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