Sources of annuity funds

Where do you get the money to buy an annuity; here are five sources

While annuities can provide the peace of mind of a guaranteed income stream for life or a specified period, they also typically require a large upfront investment. Many people who would benefit from the guaranteed income stream of an annuity lack the cash to make the initial deposit.

However, many retirees and those approaching retirement have other assets that could be liquidated or rolled over into an annuity contract. Here are five common sources of funds for an annuity:

Life insurance proceeds or inheritance

Many older individuals are fortunate to be the beneficiary of a life insurance policy or to inherit part of the estate of a parent or other loved one.
Placing some or all of that windfall into an annuity contract can serve two purposes. First, it can guarantee a stream of income for life or a specified period. Second, it can protect you from spending the money too quickly.

People often lack the discipline to wisely spend or investment an unforeseen large sum of money. There isn’t a windfall large enough that can’t be spent through, as evidenced by the many lottery winners and professional athletes who file for bankruptcy after depleting their fortunes.

By placing an inheritance or life insurance payout into an annuity, you can create a stream of payments that can last for a set period, such as 20 years, or you can designate it to last for your lifetime.

An existing life insurance policy you own
If you own a whole life or universal life insurance policy, it may have cash value. If you determine that you no longer need the life insurance protection, you could surrender the policy for its cash surrender value and use those funds to buy an annuity contract.

Before you make this decision, you should work with a licensed insurance professional to determine if the cash value of your insurance policy provides a better return and more tax advantages than an annuity contract. Also keep in mind that many annuities have death benefits as well.

Existing retirement accounts
If you’ve put aside money in a 401(k), IRA or other tax-qualified retirement plan, you may have a sizable account balance available for retirement income. But in many cases, retirees are concerned about having enough to live in throughout retirement, and they’re further concerned about suffering market losses that will deplete those assets.

Some advisers recommend retirees convert their retirement plans into annuities. One of the advantages of rolling over a 401(k) into an annuity is that you will not be assessed with a distribution tax. When you buy an annuity with IRA or 401(k) funds, the insurance company creates an IRA holding accounts for those funds. For tax purposes, the arrangement is essentially the same as rolling over a 401(k) into another 401(k) or IRA.

You will owe income taxes on 100 percent of each withdraw from the annuity. Plus you will be assessed a tax penalty if you withdraw annuity funds before age 59 ½, the same as you would if you left the money in your 401(k).

The bigger advantage to rolling over 401(k) funds into an annuity is the peace of mind of having a guaranteed income stream and not having your retirement funds exposed to the whims of the stock market.

CD or other savings account
Similar to a qualified retirement plan, money that is sitting in a savings account could last longer if used to purchase an annuity. Provided you purchase a fixed or indexed annuity, you have the same safety of principal offered by a CD or savings account, but with the potential for greater returns.
Sale of real estate, stock or other assets of value
Some retirees find themselves in the situation where they don’t have much cash for retirement, but they have valuable non-liquid assets, such as real estate holdings, stocks, and mutual funds, or partial ownership in a business. In this case, it may be time to sell those assets and use the proceeds to buy an annuity, which will provide a stream of income payments. Keep in mind, however, that if the asset is worth more than what you purchased it for, you may have capital gains taxes to pay.