Can You Rollover a 401k to an Annuity? Risks and Rewards

If you are changing jobs or near retirement, you may be considering what to do with your 401(k) or 403(b) retirement plan. Transferring all or part of the assets in this plan to an annuity can provide benefits, especially if you are interested in creating a lifetime income stream to supplement social security payments. But this strategy may not be for everyone.

An annuity is a financial product issued by insurance companies that can provide tax-deferred growth and ultimately provide a steady income stream for a specified period of time or for life.

While annuities offer unique benefits, they also come with certain challenges and considerations.

And, as usual, it is never a good idea to put all of your retirement assets in one financial vehicle. Let's explore the advantages and drawbacks of transferring your 401(k) to an annuity.

What Are the Rules for a Rollover?

The rules for rolling money from a 401(k) to an annuity can vary depending on your specific circumstances and the type of annuity involved. Here are a few rules to be aware of:

• Your employment status matters. In most cases, you must separate from your employer or meet your plan's eligibility requirements to initiate a rollover from a 401(k) to an annuity. Active employees will likely have limited options for rolling over their funds.
• Understand your specific plan rules. Review your 401(k) plan's rules and provisions regarding rollovers. Some plans may allow withdrawals while you're still employed or offer specific annuity options within the plan itself. Your plan advisor can help you understand your plan's options, which will help you determine the available choices for rolling over your funds.
• Qualified longevity annuity contracts (QLAC) rollover considerations. If you're interested in a QLAC, which is a type of annuity designed to defer required minimum distributions (RMDs) of retirement funds until later in life, there are specific rules to follow. The maximum amount that can be rolled over into a QLAC is limited to a certain percentage of your total retirement savings, currently $135,000 or 25% of your account balance, whichever is less.
• Rolling over to an existing annuity. What if you already own an annuity and want to transfer funds from your 401(k) to that existing annuity? You may be able to use a 1035 exchange. This provision allows for a tax-free exchange of one contract for another, provided certain conditions are met.
• Be aware of tax implications. Depending on the type of annuity and the nature of the rollover, there may be tax implications. A direct rollover from a 401(k) to a traditional IRA is typically not subject to immediate taxes. Of course, future distributions will be subject to income tax. But if you are rolling over funds from a Roth 401(k) to a Roth IRA or annuity, it secures the tax-free nature of qualified distributions. Your financial advisor and tax specialist can assist here.

What About Roth IRAs?

Money you place in a Roth IRA is not tax deferred — you pay income taxes on the money before depositing it in the Roth IRA.

If you roll over your Roth IRA savings into a Roth IRA annuity, you won’t have to pay income taxes on the money when you take withdrawals from the annuity.

Direct Rollovers vs. Indirect Rollovers

There are two primary methods for moving your money from a 401k to an annuity.

With a direct rollover, your money is moved directly to the annuity company, bypassing you and your bank. This method is typically preferred as it can be executed seamlessly with an account-to-account wire transfer.

Indirect rollovers are a little trickier because the money moved from your retirement account to your bank, then to the annuity company. The IRS pays close attention to these types of transfers.

With either method, direct or indirect, there should be no tax impact so long as the rollover is completed in 60 days.

What are the Risks of a 401k Rollover?

Rolling over money from your 401(k) to an annuity may present some risks and things you should consider before making the transfer. Here are a few:

1. Flexibility. Annuities are long-term financial contracts and, as such, limit your access to funds and may have a penalty for early withdrawals. Once you convert your 401(k) to an annuity, you may face restrictions on withdrawing money or making changes to your investment strategy. So only commit money that you won't need access to for a while.
2. Your money is locked in. Annuities provide a steady stream of income over time. If you need a large sum of money for an emergency or unexpected expense, accessing the funds within an annuity may be difficult or costly. It is always a good idea to diversify your source of funds in retirement and not put all your eggs in one proverbial basket.
3. Annuities can come with high fees. Some annuities, especially the variable annuity variety, can take a chunk out of your returns because they charge various fees. These can include sales charges, administrative fees, and investment expenses. These fees can erode the overall return on your investment and reduce the amount of income you receive. Be sure to consult with a financial professional to help you choose the annuity type that is right for your unique situation.
4. Inflation. Fixed annuities provide a guaranteed income stream, but they may not keep pace with inflation over the long term. Fortunately, there are usually inflation riders available to support the purchasing power of your annuity income. Make sure you ask about this feature if you are creating an income annuity.

When Should Someone Consider Rolling Over Their 401k to an Annuity?

 There are a few solid reasons why you might consider a 401(k) to annuity rollover:

• Lifetime income. This is the core benefit of annuities. Annuities offer the potential for a guaranteed stream of income for a period of time that you select, even for the rest of your life. This can be valuable if you are concerned about outliving your savings or if you don't have other foundational sources of retirement income.
• Tax advantages. Rolling over a 401(k) to certain types of annuities, such as a qualified longevity annuity contract (QLAC) or a Roth IRA annuity, may provide tax benefits. As we mentioned above, a QLAC allows you to delay required minimum distributions (RMDs) and the taxes associated with them until a later age, allowing your funds to potentially grow further.
• Protection against volatility. If you choose a fixed annuity, like those available from Canvas Annuity, your principal is protected from market downturns. This can provide stability to your retirement plan and can provide peace of mind during periods of economic uncertainty.
• Estate planning. Annuities can be a useful vehicle for passing on money to beneficiaries because they usually feature death benefit options. For example, your beneficiaries can receive the remaining balance of the annuity or a guaranteed minimum amount.

Final Thoughts

Before deciding to roll over your 401(k) into an annuity, it's important to carefully review the terms and conditions of your 401(k) plan and the annuity contract into which the funds will be transferred.

Special consideration should be given to understanding the fees involved, your individual financial goals, risk tolerance, and need for retirement income.

You can speak with a licensed specialist at Canvas Annuity who can walk you through the simple steps to move some money directly from your 401(k) to a fixed annuity.

Canvas offers industry-leading guaranteed rates of return on annuities and the ability to turn your annuity into a stream of income that you can't outlive!