When You Roll Over an IRA or Annuity Do You Pay Taxes?
An individual retirement account and an annuity are both used in retirement planning, but they are different instruments. An IRA is a sort of savings account, usually established with a bank or other financial institution. An annuity is a contract with a life insurance company that can pay out money to an account holder at regular intervals. An IRA can buy an annuity, and an annuity can fund an IRA.
Both IRAs and annuities can be exchanged for other types of retirement plans, without income tax consequences if both accounts have the same tax status. A Simple Employee Pension or SEP IRA, for instance, can be rolled over into a traditional IRA because both are tax-deferred programs. An annuity can’t be rolled over, but it can be exchanged tax-free for another, comparable annuity under a “Section 1035” policy of the Internal Revenue Service.
A SIMPLE or Savings Incentive Match Plan for Employees IRA can be rolled over after it has been established for two years. SIMPLE, SEP and traditional IRAs are all funded with tax-deductible contributions. So they can be rolled over from one to the other without any tax liability, as long as the transfer is done with funds going directly from one institution or account into the other account without passing through the account holder.
The IRS allows tax-free exchanges of annuity contracts, so long as they have the same tax status. However, the annuity company may charge a “surrender” fee. Under 1035 rules, the old and new annuity contracts must be for the same person. You can exchange two old annuities for one new one, but cannot add a person to the new annuity.
59 1/2 Rule
Both IRAs and annuities are subject to the “59 1/2 rule.” That is, distributions of tax-deferred funds before age 59 1/2 will be taxed as ordinary income, but with a 10 percent early-withdrawal penalty. That can be avoided by establishing “substantially equal periodic payments,” a series of regular distributions taxed as ordinary income when they are made. Those must continue for the life of the account holder or until he reaches 59 1/2, whichever is longer.
A “lump sum” distribution of a company-sponsored IRA, like a SEP or SIMPLE, might be exempt from withdrawal penalties if it is used to buy a lifetime annuity, which assures regular payments for the life of the account holder. It also can be used for a fixed annuity, which provides payments for a specific time period. A lifetime annuity expires with death of the account holder. Fixed annuity payments continue for the specified time, to a beneficiary if the account holder dies.
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