How to Use an Annuity in Your Individual Retirement Account

Takeaways

• Annuities, particularly Qualified Longevity Annuity Contracts (QLACs), can be used within Individual Retirement Accounts (IRAs) to manage income, defer taxes, and provide peace of mind in retirement.
• While QLACs offer specific tax advantages, other annuity types and alternative strategies can also be considered to meet diverse retirement income and estate planning goals.

You’ve worked tirelessly to build your nest egg during your working years, and now, as you approach or enter retirement, the “golden years” may not appear as carefree as they once did.

People are living longer, inflation is stretching every dollar further than expected, and the markets are anything but predictable. Add in the rising cost of health care and the disappearance of traditional pensions, and even well-prepared retirees are asking: Will my savings last?

At the same time, the Internal Revenue Service (IRS) requires you to begin withdrawing from your traditional Individual Retirement Account (IRA) whether you need the income or not. These Required Minimum Distributions (RMDs) can bump you into a higher tax bracket, reduce the compounding power of your investments, and force tough financial decisions at exactly the wrong time.

For those looking for more control, predictability, and peace of mind, annuities within an IRA — particularly tools like the Qualified Longevity Annuity Contract (QLAC) — offer a way to manage income, reduce risk, and preserve the dream of a comfortable retirement.

RMDs, QLACs, and the Annuity Carve-Out Strategy

One of the major challenges for traditional IRA owners approaching retirement is how to withdraw funds without triggering unintended — and undesired — tax consequences. RMDs are central to that issue.

When Congress first authorized the IRA in 1974, the idea was simple: let workers defer taxes on income they’d use later in retirement. But the IRS wasn’t going to let those tax breaks last forever. RMDs were baked into the deal from the beginning.

Originally, IRA holders were required to begin withdrawals at age 70½. The SECURE Act (2019) and SECURE 2.0 (2022) raised the RMD age as follows:

• If you turned 72 in 2022 or earlier, your RMDs already began at age 72.
• If you turn 73 between 2023 and 2032, RMDs begin at 73.
• For those born in 1960 or later, the RMD age rises to 75 beginning in 2033.

On paper, these delayed start dates appear to give retirees more flexibility. But for retirees who don’t need the income right away, they can create complications:

• Higher taxable income in later years, potentially pushing retirees into higher tax brackets
• Surcharges on Medicare premiums
• Reduced compounding power due to earlier-than-desired withdrawals
• Unwanted income timing, especially for early retirees aiming to delay tapping their IRAs

Fortunately, Congress didn’t leave retirees without options. Recognizing that more Americans risk outliving their savings, lawmakers introduced a carve-out strategy in the form of QLACs.

Created by the U.S. Treasury in 2014 and expanded under SECURE 2.0, a QLAC is a special type of deferred income annuity purchased inside a traditional IRA or 401(k).

Unlike most IRA investments, money placed in a QLAC is excluded from your RMD calculation, potentially for more than a decade. Here’s a simplified look at how it works:

• You can use up to $200,000 of your IRA or 401(k) to purchase a QLAC
• The QLAC pays a guaranteed stream of income starting at a future age (up to 85)
• Until then, no RMDs are required on the money used to purchase the QLAC

For some retirees, QLACs are a game changer, offering a way to defer taxes, postpone income until it’s truly needed, and create a hedge against outliving their assets.

In addition, because the value of the annuity contract is excluded from the plan balance used to determine RMDs, if you die before receiving the full value of your QLAC, the unpaid portion of your original investment can be returned to your IRA and passed to your heirs.

But QLACs are not for everyone; they’re illiquid and irrevocable. If you don’t live long enough to collect payments, your heirs may receive little or nothing, unless you’ve selected optional features like return of premium or joint-life coverage. And while SECURE 2.0 introduced more flexibility, the rules remain complex, and the contracts are not easily undone.

Nonetheless, for retirees in strong health, with sizable IRA balances, and a desire to manage long-term income while minimizing RMD exposure, the QLAC stands out as a rare solution: IRS-approved, actuarially sound, and purpose-built to address longevity risk.

Other Annuities That Can Be Used Within an IRA

An annuity is essentially a contract with an insurance company where you exchange a sum of money for guaranteed payments, typically for life or a specified period.

Annuities can be purchased both outside and within an IRA. When used inside an IRA, they can give retirees the benefits discussed above: helping secure a predictable income stream, potentially mitigating longevity risk, and, when structured as a QLAC, an RMD workaround. Annuities can also be part of long-term care planning.

It’s important to understand that when a “standard” annuity (i.e., one not designated as a QLAC) is held within an IRA, the primary benefit isn’t added tax deferral. Your IRA already does that. Instead, the value comes from layering the annuity’s unique features, such as income guarantees or principal protection, onto an already tax-advantaged retirement account. This combination can be particularly appealing to retirees who want stability, simplicity, and protection from market volatility.

Several other types of annuities can be used strategically within IRAs for retirement planning:

• Immediate Annuities. Also known as Single Premium Immediate Annuities (SPIAs), these begin paying income almost immediately after purchase (usually within 12 months). They convert a lump sum of retirement savings into a steady stream of income.
• Deferred Income Annuities (DIAs). Like QLACs, DIAs pay out a guaranteed income stream starting at a future date. Unless they meet QLAC rules, they don’t receive the same RMD exclusions, but they can still serve as a planning tool for later-life income needs.
• Fixed Indexed Annuities (FIAs). These annuities have returns tied to a market index (like the S&P 500), but include downside protection (i.e., your principal won’t decrease due to market losses). Within an IRA, they can serve as a conservative growth vehicle with the potential for guaranteed income via optional riders.
• Variable Annuities (VAs). A variable annuity provides market exposure through investment subaccounts, with optional riders for income guarantees. While they offer greater growth potential, they also carry market risk and typically higher fees. Inside an IRA, their value lies in lifetime income guarantees, not added tax sheltering.

Each type of annuity carries its own tradeoffs in terms of liquidity, fees, growth potential, and guarantees. But for retirees concerned with income reliability, longevity protection, or estate planning goals, annuities can be part of a broader retirement income strategy.

Types of Annuities: A Comparison.

Practical Considerations for Estate Planning

Annuities can play a role in retirement income strategies, but their complexities extend into estate planning and should not be overlooked from a legacy perspective. Key considerations include:

• Fees and Liquidity. Annuities often carry various fees and surrender charges that can reduce the value passing to heirs. It’s important to maintain enough liquid assets outside the annuity to avoid costly early withdrawals.
• Inflation Risk. Fixed income annuities may lose purchasing power over time unless you opt for inflation riders, which typically reduce initial payouts. This can affect the long-term value of income for both you and your heirs.
• Taxation and Inherited IRAs. Under recent SECURE Act changes, most nonspouse beneficiaries must distribute inherited IRA assets, including annuities, within 10 years, which can accelerate taxable income and complicate legacy planning. Spouses retain more flexibility.
• Estate Tax Impact. The value of annuities inside IRAs is included in your taxable estate and may affect estate or inheritance taxes at the state level, even if federal thresholds are not met.

Understanding these factors helps ensure your retirement income strategy not only matches your personal retirement goals but also fits into your long-term plans for your beneficiaries.

Alternatives to QLACs and Annuities

Annuities are one way to manage retirement income and longevity risk. For more flexibility, liquidity, or growth potential, other options can work either alongside or instead of annuities. Some of them are:

• Bond Ladders. Buying individual bonds with staggered maturities can create a steady stream of income with predictable payouts. They’re more liquid than annuities and help manage interest rate risk, though they lack lifetime income guarantees.
• Dividend-Paying Stocks and Funds. High-quality dividend-paying stocks or mutual funds offer recurring income and potential for long-term growth. Dividends aren’t guaranteed, but these assets are highly liquid and often receive a step-up in basis for heirs.
• Systematic Withdrawals. Withdrawing a set percentage from a diversified investment portfolio is a flexible, common approach. It allows for liquidity and growth but carries market risk and requires careful planning to avoid prematurely depleting assets.
• Delaying Social Security. Waiting until you reach age 70 to claim Social Security benefits can significantly boost guaranteed lifetime income and reduce pressure on IRA withdrawals early in retirement.

Each strategy has its own trade-offs in terms of taxes, risk, flexibility, and legacy goals. The right mix depends on your personal situation and preferences and should be coordinated in conjunction with your financial and estate plans. For professional advice about the planning strategies that are right for you and your family, reach out to a local attorney.