Can Annuities Be Changed to an IRA Without Tax Penalty?

by Sharon Platz
Annuities can be a complicated part of your investing puzzle.

The type of annuity you own dictates whether you can roll or transfer the annuity over into an IRA without tax penalties. You can move your qualified annuity without penalty; the Internal Revenue Service will hit you with a penalty if you try to move your non-qualified annuity into an IRA account.

Qualified Annuity

A qualified annuity mirrors a traditional IRA in that you fund the annuity with pre-tax dollars. The IRS dubs this type of annuity “qualified” because it might qualify you for tax deductions on your contributions. It is also called a qualified annuity because it is usually set up by your employer and sits in a qualified employer-sponsored retirement plan, such as a 401(k) or 403(b).

Non-Qualified Annuity

If you bought the annuity yourself, you have a non-qualified annuity. A non-qualified annuity is funded with after-tax dollars and does not sit within any qualified retirement plan, such as your 401(k) or an IRA. Much like Roth retirement plans, the distributions from a non-qualified annuity are not taxed because you paid taxes on the money when you bought the annuity.

Moving Qualified Annuity

Because a qualified annuity already resides in a qualified retirement plan, it is treated much like a qualified plan, and you can roll over or transfer the funds into an IRA. The better choice of the two options is to transfer your funds. This absolves you of any money-handling responsibility. You notify your annuity plan holder and your IRA holder of your intent to transfer the funds into an IRA, fill out any necessary paperwork and let them make the transfer. A rollover gives you possession of the annuity funds, which you must then deposit into your IRA within 60 days. If you don’t, Uncle Sam will get cranky and treat your rollover as a distribution, which means income tax and a 10 percent tax penalty if you are under the age of 59 1/2. You must replace any withholding fees, which are 20 percent as of 2013, and taxes your annuity plan administrator pulled from your annuity prior to handing the funds over, as well, so your rollover amount is equal between the two plans.

Moving Non-Qualified Annuity

You can’t transfer or roll over a non-qualified annuity -- it doesn't sit within a qualified retirement plan. You can cash out your non-qualified annuity and use the funds to open an IRA, but you’ll get dinged with any early surrender fees the annuity holder charges, plus the 10 percent IRS early distribution tax penalty if you are under age 59 1/2. You might also be restricted on how much you can actually move into an IRA and pay additional fees if you withdraw more than the IRS-designated annual limits to deposit into an IRA. For example, the 2013 contribution limits for IRAs are $5,500 for those under 50, and $6,500 for those 50 and over. If you're under 50 and withdraw $6,000 out of your non-qualified annuity and deposit it into an IRA, you'll pay a 6 percent excess contribution tax on top of all the fees and penalties.

Considerations

Both types of annuities have different tax benefits; your qualified annuity is tax deductible, and you don’t have to pay taxes on money until you begin receiving distributions. Your non-qualified annuity is funded with post-tax dollars, so your qualified distributions are tax-free. Transferring or rolling over your qualified annuity is much easier than attempting to move your non-qualified annuity into an IRA. Consider the annuity and IRS fees and penalties prior to making the decision to rock your annuity’s boat.

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