Placing an annuity in an IRA may not be, as some say, like wearing a raincoat indoors

April 18--Annuities are contracts between individuals and insurance companies that provide the purchaser with a steady stream of income during retirement. They often play a role in replacing or supplementing other fixed income streams, such as pensions and Social Security.

But many financial advisers say it makes little sense to hold an annuity in a retirement account such as a traditional or Roth IRA because it would be similar to wearing a raincoat indoors. One of the main advantages of an annuity is that your money grows tax-deferred. However, any asset -- stocks, bonds and annuities -- that are held in an IRA is automatically tax-deferred.

"Is it a good idea to buy an annuity within an IRA? At first blush, the answer would seem to be 'no' because one of the biggest benefits of an annuity is tax deferral, which you already have in an IRA. But it's not so simple," said Ken Nuss, CEO of AnnuityAdvantage, a national marketplace for annuities based in Medford, Ore.

"If an annuity product meets a client's needs in the best way, the fact that you are putting a tax-deferred product inside of an IRA that already provides tax deferral is irrelevant," he said.

His example is a client who needs to supplement her income with a five-year fixed-rate investment. She could choose a corporate bond paying 2.5 percent, a bank CD paying 2 percent, or a fixed annuity yielding 3 percent.

"In that example, two of the options are not tax-deferred," Mr. Nuss said. "But the tax-deferred fix annuity provides the best return for that particular client's needs."

Annuities come in different shapes and sizes. Essentially, how they work is the investor hands over a lump sum of cash to an insurance company, which invests the money and guarantees the annuity owner a stream of guaranteed lifetime income. The drawback is that once the buyer enters the contract, he cannot get his capital back and has little to no ability to change the income stream once it starts.

There are no direct fees associated with fixed-rate annuities. Variable annuities are a different story. Mr. Nuss said he does not sell variable annuity products.

Variable annuities can potentially lose money and the earnings rate is not guaranteed. An annual fee for variable annuities that typically ranges from 1 percent to 2 percent also is charged to the investor's account, which acts as a drag on the money that would otherwise accumulate.

Pittsburgh financial adviser Robert Fragasso said he is adamantly against placing variable annuities in an IRA but has no objection to fixed annuities as long as the rate is competitive and the time period of the rate guarantee commensurate with competitive products.

"The problem I have is using an annuity as a pension," Mr. Fragasso said. "You are locking your capital up forever and you only get a monthly payment. What if you need the money? What if you or your spouse becomes ill and you have to self-pay for medical treatment? What if a child or grandchild needs help and you have locked up all your capital?

"What if you have a lifestyle or investment opportunity and you only have a monthly check?" he said. "Flexibility with one's money is a valuable commodity.

"Once you annuitize that money and make it a monthly pension, you've lost all flexibility. You can annuitize for your life and your spouse's life, and what if the next day you are both killed in an accident. What do your kids get? Nothing."

In an age where company pensions are going by the wayside, Mr. Nuss said a fixed annuity can be a viable substitute for those people who have saved enough to purchase a meaningful retirement income stream.

He noted every annuity product has its own minimum deposit requirement, which typically ranges between $5,000 and $20,000. Single contribution annuities are best suited for people who can make a one-time investment large enough to meet their needs. Flexible premium annuities allow purchasers to make ongoing contributions until they are ready for their income stream to begin.

"My main contradiction to the advice handed down by many financial advisers is you can't lump all annuities into one category and say none of them should be placed in an IRA account," Mr. Nuss said.

Tim Grant: [email protected] or 412-263-1591.

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