Ken Nuss

A Roth IRA is a uniquely powerful retirement-savings tool because you won’t pay taxes on the money you withdraw during retirement.

Different types of annuities accomplish different things and have distinct pros and cons—like the Swiss army knife of personal finance. Since they’re so varied, one type or another can work well for a Roth IRA.

What kind of annuity works for a Roth? It depends on which stage of your financial life you’re in. In the 

stage, you’re building wealth for retirement. In your 

 stage, you’re retired and receiving income from your savings.

Here’s how Roth annuities can work in each stage.

. With the stock market continuing to break records, it may be vulnerable to a major long-term downturn.

When you’re young, you can ride out the ups and downs. But if you’re in your 50s or 60s, you may want to get growth potential without taking the risk of losing Roth money you’ll need during retirement. If so, an indexed annuity might be a good choice for you.

It pays interest based on an underlying market index, such as the S&P 500 or the Dow Jones Industrial Average. While the interest earnings are locked in, up to a stated cap (you may not get all of the upside) each year, you’ll never lose money when the index declines.

While indexed annuities are linked to one or more underlying market indexes, their value does not vary from day to day. Instead, they pay a varying amount of interest that is credited and locked in each year on the anniversary date of the contract.

Since equity markets can be volatile, indexed annuities are designed to be held long-term, whether yoked to a Roth IRA or not.

, also called a multi-year guarantee annuity, or MYGA, is a more conservative choice. It works like a bank CD, paying a set interest rate for a set period. Fixed-rate annuities these days pay much more than CDs of the same term.

Fixed-rate annuities can play a key role in asset allocation. Let’s say you decide to split your Roth assets up 50-50 between equities and fixed income. A fixed-rate annuity can give you a much higher rate of interest than you’d get today with safe fixed-income alternatives such as CDs and Treasury bonds.

. Annuity interest is paid and compounded annually.

How to get tax-free lifetime income during retirement

Other than a traditional employer pension or Social Security, an 

 is about the only vehicle that can guarantee an income for as long as you live. By combining an income annuity with a Roth, you can get guaranteed income for life, with a big plus: 

If you need income from your Roth very soon, consider an 

 You can open a Roth annuity with a single payment (such as a tax-free rollover from an existing Roth IRA) to an insurance company. The insurer in turn guarantees you a stream of income.

You can choose how long the payments will last—for instance, 15 years. Most people, however, choose lifetime payments as “longevity insurance.”

You can receive your first monthly income payment a month after your annuity contract is issued.

If you’re married, consider the joint-income option. With it, your spouse will receive regular monthly income payments for the remainder of his or her life too. Payments to a surviving spouse are always tax-free.

If you don’t need income right now, consider a 

. Here, your income stream will begin at a future date you choose.

By deferring payments, you let the insurer credit more interest over the years on your behalf, and you’ll ultimately get more monthly income. For instance, by delaying lifetime annuity payments from age 65 to 75, you’ll get about 85% to 90% more each month. On the other hand, you and/or your spouse won’t receive the deferred payments as long.

. The rider guarantees a certain income regardless of the performance of the annuity. It provides income like a deferred income annuity, plus the potential upside of an indexed annuity. It’s sometimes called a “hybrid” annuity.

The downside is cost. The rider typically costs about 1% of the annuity value annually. The insurer deducts this amount from your policy.

The advantage is retaining your money. Unlike an income annuity, which typically has no cash surrender value, an indexed annuity with an income rider lets you keep your money while guaranteeing lifetime income, starting on a date you choose.

Is the extra cost worth it? It all depends on your situation and goals and your desire to leave money to your heirs.

Whether you’re saving for future retirement or are currently retired or soon will be, annuities offer a range of often-overlooked strategies for the Roth IRA and amplify its advantage of tax-free retirement income.

, a leading online provider of fixed-rate, fixed-indexed, and

annuities. He launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities. He writes on retirement income and annuities regularly for several leading financial websites.

A free quote comparison service with interest rates from dozens of insurers is available

Articles

A Roth annuity can create tax-free lifetime income during retirement or reduce your risk while saving for retirement.

Often-Overlooked Way to Fund Your Roth IRA Has Many Advantages

Interest rates on most safe investments, such as savings accounts, bank CDs, money market accounts, and Treasury bonds are super low these days. When you factor in even a tiny bit of inflation, you’re losing money in them, even before you pay income tax.

What are the best alternatives for people who want to get a higher guaranteed rate of interest?

It’s a big issue for people in their late 50s and older who don’t want to risk too much in the stock market and for retirees who rely on savings for income. Here are three good alternatives, all classified as fixed annuities, but different from one another.

Fixed-rate annuities pay higher guaranteed rates

Also called a multi-year guaranteed annuity, a fixed-rate annuity acts a lot like a bank CD. Both guarantee a rate of interest for a set period. But there are some key differences.

One is that fixed-rate annuities pay much higher rates than comparable CDs today. As of early February 2021, you can earn up to 3.00% a year on a five-year fixed-rate annuity and up to 2.40% on a three-year contract, according to AnnuityAdvantage’s online rate database.

The top rate for a five-year CD is 1.00% and 0.85% for a three-year CD, according to Bankrate.

Annuity rates have held up remarkably well so far, but are declining. If you’re interested in a fixed annuity, by acting now you’ll probably get a better rate today than next month or beyond.

Another difference is that with an annuity, interest is tax-deferred until you withdraw it. You can either receive the interest annually and pay tax or let it compound in the annuity and thus defer taxes.

There’s one major caveat. If you withdraw money from an annuity of any type before age 59½, you’ll normally owe the IRS a 10% penalty on the interest earnings you’ve withdrawn, plus regular income tax on it. If you’re much younger than 59½, don’t buy an annuity unless you’re sure you won’t need to take out money before that age.

Annuities of all types are guaranteed by the issuing insurance company. They are not FDIC insured. State annuity guaranty associations do provide a solid extra level of protection, however.

Fixed annuities are suitable for both nonqualified accounts (savings that would otherwise be taxable) and in qualified retirement plans, such as IRAs, Roth IRAs, and 401(k) and 403(b) plans. 

Fixed indexed annuities offer potentially higher returns over the long term

Indexed annuities credit interest based on the growth of a market index, such as the S&P 500 index. The interest rate thus fluctuates annually. In up years, you’ll profit. In down years, you’ll lose nothing but won’t earn anything.

So, for example, in year one you might earn 9%, 0% in year two, and 4% in year three, and so on. If you’re okay with the risk of earning nothing some years, in the long run, you’ll likely earn more interest than you’d get with a fixed-rate annuity.

Indexed annuities are for people who want to save for the long term and limit their risk without precluding growth. They’re not typically suited for people who need steady income right away to cover living expenses.

Think of them as a distinct third class in an asset-allocation plan: fixed-income (CDs, bonds and other fixed annuities); equities (stocks and stock funds); and indexed annuities.

Because there are different crediting methodologies and caps, it takes some research to compare and determine which indexed annuity is best suited for you. Work with an annuity specialist who has the necessary resources and training to assist you in this process. 

Income annuities produce much more guaranteed income

If you’re looking for the most guaranteed income, here’s an alternative you may not have thought of: an income annuity. Unlike fixed-rate or fixed indexed annuities, once purchased, income annuities have no accumulation value, so they don’t pay a stated rate of interest. You pay a lump sum or a series of deposits to the insurer, which guarantees a stream of income.

You choose how long the payments last—for example, you could select ten years. Most people, however, choose a 

 annuity that will pay you (and optionally, your spouse) guaranteed monthly income no matter how long you live.

Income annuities produce more income because each income payment is made up of both taxable interest and tax-free return of principal (your own money coming back to you). It’s a bit like the flip side of a mortgage, where each payment you make includes principal and interest.

A mortgage gets paid off eventually. However, lifetime income annuities keep on paying the same amount, even 

the insurer has repaid your entire principal.

Lifetime income annuities serve as longevity insurance. They protect you against the risk of running out of money should you live into your 90s or beyond.

Deferred or immediate payments—your choice

A deferred income annuity, which pays out starting on a future date that you choose, lets your money grow tax-deferred until you start receiving income. If you can afford to wait, it’s usually the better choice because the deferred income payments will be larger than immediate payments.

If you need substantial income soon, an immediate annuity can be a great solution. Typically, you’ll start receiving monthly payments within about a month of purchase. Many insurers will let you delay the start by up to a year if you like.

, a leading online provider of fixed-rate, fixed-indexed and

Three alternatives to low-rate CDs, Treasuries, and Money Market Accounts

Savers Can Earn More, Safely

Annuities are designed to build wealth and income for your retirement through tax deferral. Interest earned in a deferred annuity (the most popular type) is not taxed until withdrawn. Deferring taxes 

 savings growth because interest compounds faster without withdrawals needed to pay taxes.

Compounding occurs when interest is paid on previously earned interest. Most investments that earn interest, such as money market accounts, savings accounts, certificates of deposit, and most bonds, create taxable income.

Since you’re paying federal (and often state) income tax on it each year, you’ll have less after-tax interest to compound, and your savings won’t grow as fast.

 of your interest is compounded until withdrawn.

Annuities have some unique tax advantages. In some cases, they can even be used to pay for long-term care without the usual taxes on distributions! But there are some potential tax pitfalls.

Taxation outside and inside of retirement accounts

Annuities can be purchased with pretax funds or after-tax funds. Pretax accounts such as IRAs, 401(k) and 403(b) plans are qualified retirement plans. If you use an annuity to fund one, it’s thus called a “qualified” annuity.

In contrast, “nonqualified” annuities are purchased with ordinary after-tax money. By shifting some of your money into a nonqualified deferred annuity, you can cut your taxes.

Interest earned in both qualified and nonqualified annuities is not reportable on your tax return until you withdraw it.

However, qualified annuities held in retirement accounts are subject to the required minimum distribution (RMD) rules. You must take withdrawals each year after you reach age 72.

Nonqualified annuities are not subject to RMD rules, so interest can continue to compound without tax until you withdraw some or all of it. This gives you great flexibility.

Let’s say you do not need more income when you’re 72. With a nonqualified annuity, you can wait until you do need the income and benefit from more years of tax-deferred growth.

Income withdrawn from all types of deferred annuities is taxed as “ordinary income,” not long-term capital gain income. This tax treatment applies to fixed-rate, fixed-indexed, variable, and income annuities.

Here are some key tax wrinkles regarding annuities.

Income annuity payments are only partially taxable.

 Your original investment—the purchase premium(s) you paid—in a nonqualified annuity is not taxed when withdrawn. Only the 

With a deferred annuity, IRS rules state that you must withdraw all of the taxable interest 

 before withdrawing any tax-free principal.

You can avoid this significant drawback by converting an existing fixed-rate, fixed-indexed or variable deferred annuity into an income annuity. Or you can buy an income annuity in the first place.

An income annuity provides a stream of guaranteed payments, starting either right away with an immediate annuity or in the future with a deferred income annuity. As mentioned above, each payment includes both taxable interest and tax-free return of your premium.

 depends on how long you’ve held the annuity, how much interest you’ve earned and how long the payments will last; but, for example, 75% of each payment might be tax-free return of principal and 25% taxable.

 If you withdraw money from your annuity before age 59½, you’ll typically owe Uncle Sam a 10% penalty on the interest earnings you’ve withdrawn as well as ordinary income tax on the amount. If you are permanently disabled at the time of the withdrawal, the IRS will waive this penalty.

 Annuity interest that is used to pay long-term care insurance premiums can usually be withdrawn tax-free. This can be a big advantage.

 If you’re married, your spouse can assume the ownership of your qualified or nonqualified annuity at your death without any taxes.

Children beneficiaries are required to claim only the untaxed portion of the annuity on their tax return. Under certain circumstances, the annuity can be distributed and taxed over a number of years. If you name a charity as your beneficiary, you can partially or fully offset income tax liability.

 You can roll over your IRA, 401(k) or 403(b) or pension plan lump-sum payout into any type of qualified annuity without taxes.

 Contributions made to a qualified annuity are deductible within IRS limits for retirement plans. Premium payments to nonqualified annuities are not.

 Nonqualified annuities may be exchanged tax-free for another nonqualified annuity—a so-called 1035 exchange.

 Because the funds in a pretax qualified annuity have never been taxed, the 

 amount of the payments received each year is taxable. These amounts count toward your required minimum distributions (RMDs).

 A qualified longevity annuity contract, or QLAC, is a qualified annuity that meets IRS requirements. It lets you defer up to 25% of RMDs until age 85 and thus reduce your taxes until the payments begin. QLAC income is 100% taxable, but it’s money you’d eventually have to withdraw from your IRA anyway.

Over your lifetime, you can allocate 25% of the total of all your IRAs or $135,000, whichever is less, to a QLAC.

How to cut your taxes and avoid surprises.

Annuities Offer Powerful Tax Advantages Plus Some Avoidable Pitfalls 

It’s time to do a year-end financial review and set your path for 2021. You’ll make sure your savings and investments are aligned with your goals, reduce income taxes, and ensure you’ve dotted your i’s and crossed your t’s.

Review IRA, 401(k), and other retirement-plan contributions

. If you haven’t fully funded your retirement plan(s) this year, consider what you can afford to salt away. Contributions to 401(k) plans reduce your taxable wages. They are due by December 31, and many employers will let you make an additional one-time contribution up to the IRS limit.

You may be able to save on 2020 taxes by making deductible contributions to an IRA by April 15, 2021. If your income is too high to get a deduction because you or your spouse are also covered by a retirement plan at work, consider socking away money in a Roth IRA, which has more liberal income limits.

 need to take required minimum distributions (RMDs) this year. Congress waived them for all types of retirement plans in 2020.

Review your asset allocation and rebalance if needed.

 Confounding expectations, the stock market has boomed this year. As a result, you may find that your asset allocation has gotten out of whack.

Suppose a few years ago you set your allocation as 50% equities (stocks and stock funds) and 50% in fixed-income (bonds, CDs, fixed annuities, money markets and similar instruments). Thanks to strong market performance, you’re now 65% in equities and 35% in fixed income.

You’ve done well! Now it’s time to start reallocating to get back to 50-50. Reallocating money in retirement plans as well as annuities and life insurance policies takes less planning because gains here are not taxed until withdrawn.

Some people have enough money in their retirement plans so that they can accomplish their overall rebalancing using only them. Remember, it’s your 

 asset allocation that counts, not the allocation in any one account.

If you do need to rebalance your taxable investments, be aware of tax strategy. For instance, if you have unrealized losses, you can sell off losing investments to offset gains from selling your winners. If you’re rebalancing a lot of taxable money, you may want to consult a CFP or CPA for help.

When rebalancing or reinvesting money coming due from maturing CDs or bonds, consider all your options. You may be able to get a much better rate than you expect.

 To boost the economy, the Federal Reserve has slashed short-term interest rates close to zero. Today, most savings instruments like money market accounts, CDs, and bonds pay very low rates, even if you’re willing to tie up your money for a few or several years. If you’ve got CDs or bonds that are about to mature, it pays to consider other options.

If you can afford to tie up your money till age 59½ or are already that old, there’s another choice that typically pays a higher rate: a fixed-rate annuity. Your age is important because If you withdraw money from your annuity before age 59½, you’ll owe the IRS a 10% penalty on the interest earnings you’ve withdrawn.

Also known as a multi-year guarantee annuity or a CD-type annuity, a fixed-rate annuity behaves a lot like a bank certificate of deposit, with some notable differences.

Like a CD, it pays a guaranteed interest rate for a set period, usually 3-10 years. Unlike a CD, the interest credited to the annuity is tax-deferred until you withdraw it.

While CDs today pay less than 1%, a 3-year fixed annuity pays up to 2.40% and a 5-year contract up to 3.00% annually. Annuities are not FDIC-insured but are covered by state guaranty associations, up to certain limits, that vary by state.

A fixed indexed annuity is another choice if you don’t mind a fluctuating interest rate. It credits interest based on the growth of a market index, such as the S&P 500.

In up years, you’ll profit. In down years, you’ll lose nothing but won’t earn anything. Indexed annuities are suited for people who want to save for the long term while limiting risk without precluding growth.

Make sure your beneficiaries are up to date.

 The listed beneficiaries on annuities, life insurance policies, and retirement plans will receive the proceeds on your death. Check that they’re up to date. Life changes such as marriage, divorce, the birth of children or grandchildren, and the death of a loved one may require updating your beneficiaries.

If you’re married, your spouse is normally your primary beneficiary and your child or children are contingent. If you’ve been divorced and remarried, make sure your ex-spouse isn’t still the beneficiary.

, a leading online provider of fixed-rate, fixed-indexed and immediate income annuities. He launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities. He writes on retirement income and annuities regularly for several leading financial websites. 

A free quote comparison service with interest rates from dozens of insurers is available at 

A year-end review helps you cut taxes, build retirement savings, rebalance your portfolio, and earn more interest.