Converting an IRA Annuity to a Roth?
By Ric Edelman
Watch out for unintended consequences
If you’re thinking about converting an IRA annuity to a Roth IRA, talk to your financial planner first, because such situations are quite complicated.
First, you need to verify exactly how much your annuity is worth. That’s because your tax obligation isn’t limited to the cash value of the contract. Instead it’s determined by the fair market value of the annuity, which is the cash value of the contract on the day you convert plus the actuarial net present value of any living or death benefits. (Your insurance company can calculate your NPV for you.) For example, if your annuity has a cash value of $50,000 and the death benefit is worth $200,000, you’ll owe taxes on $250,000.
Take extra care if you are only partially converting your variable annuity. When you convert an entire annuity, the annuity itself remains intact. But when you convert only part of one, you are essentially splitting off part of your annuity to create a new IRA. This sounds simple, but breaking off a piece of the annuity is the same as making a withdrawal. Depending on your annuity, a premature withdrawal could trigger the annuity to lock in a living benefit payout percentage earlier — and therefore at a much lower amount — than you had expected or planned. It could also cause the annuity to stop providing guaranteed growth.
So before you convert an annuity, talk to your advisor and your annuity provider to get a complete picture of the tax implications and overall impact on your bottom line. If there’s going to be a rude surprise, it’s better to find out before you convert.
* Variable annuities are long-term investment vehicles designed for retirement purposes, and are subject to market risk. The information in this article does not constitute an offer to sell or solicit any person to purchase any security. Investment decisions should not be made based on information in this article. This and other important information is contained in the brochures and/or prospectus, as well as the underlying fund prospectuses for variable annuities, which can be obtained from your investment advisor and should be read carefully before investing. All product guarantees are based on the claims-paying ability and financial strength of the issuing insurance company.