Question: I am considering adding an immediate annuity to my retirement portfolio. My research suggests these annuities make sense, but I wonder whether it would be better to purchase it from my 401(k) or my Roth IRA. What would you suggest?
Answer: I agree with you that immediate annuities can be an important part of your retirement plan, and your question about whether to fund it from a 401(k) or a Roth IRA is a good one. While the question is straightforward, the answer requires analysis of your objectives and personal situation.
Here are some of the considerations:
- What are your objectives with regard to these sources of retirement savings? Is it strictly about generating retirement income or would you like to leave a legacy at your passing?
- Other than Social Security, do you have additional sources of income? Filling any income gap may impact the form of immediate annuity you select. I wrote previously about this in a blog on guaranteed income vs savings.
- What is your current tax situation and what will it be in the future? Generally speaking, any amounts paid out of the 401(k) will be taxed as ordinary income during your lifetime or to a beneficiary. In contrast, amounts distributed from the Roth IRA will be free from income tax.
- How would you invest any retirement savings not used to purchase the immediate annuity? How comfortable are you with assuming market risk on these amounts?
Every situation is unique, but here’s my general philosophy:
- Generate the highest cash flow from 401(k) or a Rollover IRA accounts and “die broke” with these assets. An immediate annuity is the way to accomplish this. I wrote this blog on how to maximize tax benefits.
- If you’re comfortable investing in the market, then do so in the Roth IRA, so that the dividends and capital gains escape taxation. Also, if the Roth IRA is considered part of your legacy, then the market risk is effectively passed on to the next generation.
- If you need to supplement your income from your 401(k) or other sources, you can periodically roll out amounts from your Roth IRA to purchase more income from an immediate annuity. Of course, you would assume market risk before any roll out.
Jerry will answer your question, too, at Ask Jerry at Jerry Golden on Retirement.