By Marvin Hurwitz in Baltimore, MD
Ever since I started as a financial services and retirement advisor in the early 1980s, I have read numerous reports and heard from many so-called experts and financial planners that tax-deferred annuities should not be the source of funding IRA accounts. The reason for not using annuities in IRAs is that vehicles such as annuities and tax-free bonds are already tax-advantaged. So why take an investment that is either free of taxes (municipal bonds) or tax-deferred (annuities) and use them to fund an IRA, which is already tax-advantaged?
When you think about it, the argument does make sense. Taxes on traditional IRAs and other types of retirement accounts such as SEP IRAs may have to be paid on the interest earnings only when the funds are withdrawn. No taxes are owed on funds deposited into Roth IRAs as long as they are held for at least 5 years. It’s logical to argue that taxable investments such as stocks, mutual funds and corporate bonds are more appropriate for all types of IRAs. That’s because if they are purchased and sold outside of an IRA they could be subject to taxes either each year or when liquidated, depending on whether profits are earned and when and if dividends or interest are credited. If the profits, dividends and interest are credited in an IRA, the taxes on them are deferred until withdrawn from the IRA.
This is a convincing argument for those who are critical of using an already tax-free bond or tax-deferred annuity in an IRA. But let’s take a deep breath for a moment and look the other side of the argument. As a retirement benefits advisor, I want to help my clients receive the highest possible rate of return with the least amount of risk. Most of them are looking forward to a comfortable and secure retirement for many years. Many are already retired and do not want to risk losing any of the savings they have accumulated during their lifetimes.
There is no question that mutual funds, stocks and some corporate bonds may, and I emphasize may, outperform annuities. And, we also know that as long as these investments remain in an IRA account, they will not be taxed. At age 70 1/2, however, owners of IRAs must begin taking out required minimum distributions from their IRAs annually. And if those distributions come from dollars that were not previously taxed, they will now be subject to Federal and state taxes—the same as annuities or other tax-advantaged investments funding IRAs. This represents the great majority of IRA funding sources. Some IRA contributions may have already been taxed prior to being placed into the IRA account so these funds would not be subject to double taxation.
If we balance the potential returns and the potential risks, we find that fixed-rate or fixed index annuities will be principle protected and provide growth that may well be lower than the growth of stocks and mutual funds in particular. What makes annuity products more attractive than stocks and mutual funds, as well as taxable or tax-free bonds, for funding IRAs is that they will not lose value. They offer minimum guarantees and they will increase in value the longer they are held. They provide protection against sharp declines in the market as we witnessed during our most recent deep recession and in previous economic downturns. Think about what happened to the IRAs and other retirement accounts of those people who were set to retire during those years. Would they have been better off having their money in a more secure vehicle like an annuity? The answer is a resounding yes.
Remember, an IRA is only the envelope. The actual funding source of the IRA is the content inside the envelope. So we have to compare results of the different options available—the content.
For those who are more interested in maximizing their returns and do not mind risking potential losses, taxable investments can be very appropriate for their IRAs. But for those who want to safeguard their hard-earned assets in their retirement savings accounts and are willing to forego some upside potential in return for safety and minimum guarantees, both fixed rate and fixed index annuities need to at least be considered.
About the Author: Founder of Hurwitz Financial Services in Baltimore, MD. He has been helping retirees and individuals nearing retirement establish plans designed to achieve their retirement goals since 1981. He can be reached at 410-486-3419 or at his e-mail address at firstname.lastname@example.org.
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