A reader writes in, asking:
“I’ve read numerous articles about the benefits of purchasing a SPIA with part of my assets to create a floor of guaranteed income (along with Social Security) in retirement. But I’ve never seen any discussion of the best funds to use to pay for the annuity. Can an annuity be purchased using traditional IRA or Roth IRA dollars? If so, what are the tax ramifications of each? Can I buy a joint life annuity to cover the lifetimes of both myself and my spouse with money from my IRA?”
Yes, a single premium immediate annuity (SPIA) can be purchased using traditional IRA or Roth IRA dollars.
If you read Internal Revenue Code section 408 (which is where we get the rules for IRAs), you’ll see that IRA can stand for individual retirement account or individual retirement annuity.
In every case I’ve ever seen personally, when IRA dollars are used to purchase an immediate annuity, the annuity is created as an individual retirement annuity. And that means two things:
Whether traditional or Roth, the payments from the annuity are simply treated as distributions from the IRA and taxed accordingly.
If it’s a traditional IRA, the payment from the annuity is considered to satisfy the RMD from the individual retirement annuity each year. (Point being, you don’t have to worry about calculating an RMD amount which might be different from the payment from the annuity. The payment satisfies the RMD by definition.)
Point being, payments from a traditional individual retirement annuity will generally be fully taxable, just as would be any other distribution from a traditional IRA. (If you have basis in your traditional IRA(s) due to having made nondeductible traditional IRA contributions, a pro-rata calculation would apply.)
And if it’s a Roth individual retirement annuity, payments/distributions will be treated as normal Roth IRA distributions. So they’ll be first considered to come out of contribution amounts, then converted amounts, and then earnings. And the tax treatment will be exactly what it would be if these amounts were coming out of a Roth individual retirement account. (This calculator/tool, as well as the article linked earlier in this paragraph, maybe helpful there.)
In theory, immediate lifetime annuities could be purchased within an individual retirement account, with the payments from the annuity made back into the IRA (rather than being distributions from the IRA). The tax code does not prohibit such. I’ve never seen such a thing in real life, so it doesn’t seem that many insurance companies offer this. I am aware of one person on the Bogleheads forum who has encountered such an annuity, but it’s definitely a rare situation.
Can a Joint Life Annuity (Myself and Spouse) be Purchased with IRA Dollars?
The short answer to this question is, yes, a joint life annuity that pays out for the longer of your life or your spouse’s life can be purchased with IRA dollars. One potential point to be aware of is that things get complicated if you also pick a period certain (i.e., the annuity will pay out for the longer of your lives but will also pay out for at least X years). You’ll want to read the rules in Treasury Regulation 1.401(a)(9)-6, to make sure the period certain does not cause any problems.
What is the Best Age to Claim Social Security?
Read the answers to this question and several other Social Security questions in my latest book:
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