Q: I am 60 years old and recently retired. I would like to roll my 401(k) plan into an immediate payout annuity. Can this be done without triggering any tax consequences? Also, is it possible to set this up as a joint annuity with my wife without triggering any tax consequences? -- GT via email
A: You could roll the 401(k) account into an IRA, and invest the IRA in an annuity that would provide income for both your lives. If you did the rollover from 401(k) to IRA correctly, there would be no tax consequences.
But you haven’t asked a more basic question: Is it a good idea?
The answer is no.
Just to clarify what we’re talking about, an immediate-pay annuity is not the same as a deferred annuity. In a deferred annuity, you salt away money for the future. With an immediate annuity, you hand the insurance company a lump sum, and in return you immediately start getting a monthly check for the rest of your life.
Your principal in the annuity is invested on a tax-deferred basis. This is true even if the annuity isn't inside an IRA. The big difference: If you buy an immediate annuity with non-IRA money, part of each payment you receive is a tax-free return of principal, and part is taxable income. When the annuity is inside an IRA, every penny that comes out of it is taxable income.
There's no question that a promise of guaranteed income for life is very appealing. But immediate-pay annuities involve some big trade-offs:
First, when you buy an immediate annuity, you permanently surrender access to your principal; you can't change your mind later, get your money back, and invest it in something else.
Second, unless you have a very large sum to invest, the annuity alone probably won't provide enough income for you to live on comfortably.
Third, inflation will steadily shrink the purchasing power of that income.
The size of your monthly payment is set when you buy the
annuity. The amount depends partly on your age, sex, and state of
residence, and on prevailing interest rates at the time of purchase.
Interest rates right now are low, so this isn't a great time to lock in lifetime income, says Richard Freeman, a Westport Conn. Financial adviser.
It’s also not the best move to buy an annuity at your relatively
young age. The younger you are, the smaller the payout you can expect.
In today’s market, for example, a $500,000 annuity sold in New York to a 60 year-old man and his 58-year old spouse will pay about $2,650 a month as long as either of them is alive. By contrast, $500,000 would buy an 80 year-old and a 78 year-old lifetime income of about $3,960 a month.
"You should wait until you're at least 75 to buy an annuity -- and closer to 80 would be better," says Freeman.
In the meantime, he advises you to roll your 401(k) into an IRA that you invest in a diversified mix of no-load stock and bond mutual funds. (An IRA is tax-deferred, no matter how you invest it.)
Of course, the big challenge is figuring out an investment mix that will both grow your money enough to keep up with inflation and let you take annual withdrawals without a serious risk of running out of money.
For professional assistance, consider a program like T. Rowe Price's Advisory Planning Services. For a onetime $250 fee (which includes ongoing reviews to make sure you stay on track), this program recommends a generic mix of mutual fund and annuity investments, and a withdrawal strategy that can help you sustain purchasing power throughout your retirement without running out of money.
The recommendations are based on your answers to a questionnaire, which is followed by discussions with an investment counselor, and on a software analysis showing how different combinations of investments might perform in hundreds of possible future market scenarios. Of course you'll be told how you can implement the program’s recommendations with T. Rowe Price funds if you wish -- but there's no obligation to do so. For more information, go to www.troweprice.com .
For more information on what an immediate annuity will pay, depending on your age and the amount you have to invest, go to immediateannuities.com . You can also get quotes from some first-rate, low-cost insurers directly: USAA Life Insurance Co. (800 531 8000); Ameritas Life Insurance (800 552 3553); and Tiaa-Cref (800 223 1200).