Similar to retirement accounts like IRAs and 401(k)s, Congress provides deferred annuities a tax preference, in the form of tax-deferred growth, to encourage their use. This tax treatment does not have any outright cost; instead, it’s simply a benefit that is otherwise granted to the owner of an annuity. Yet because of the similarities in tax treatment between retirement accounts and annuities – and the fact that for much of their history, deferred annuities really were used primarily or solely for their tax deferral treatment – there is a long-standing rule of thumb for how to coordinate between the two: similar to muni bonds in an IRA, the rule is “never purchase an annuity inside of an IRA, because you don’t need tax deferral in an already tax-deferred account!”
Yet the reality is that for more than a decade, this rule has actually been rendered moot by significant changes that have occurred in the annuity landscape. While once upon a time there were few reasons to purchase a deferred annuity besides the preferential tax-deferral treatment, since the early 2000s annuities has been increasingly popular for their guaranteed living benefit riders, along with enhanced death benefit, unique investment features (in the case of certain equity-indexed annuities), or outright superior fixed income yields (with some fixed annuities). As a result, by 2012 the majority of annuities were actually being purchased with funds sourced from a retirement account, because that’s where the available money was held to be invested for such features and guarantees!
While in some limited cases, deferred variable annuities actually are making a resurgence for pure tax deferral purposes – in which case, there’s once again little reason to purchase them with retirement assets – most annuities continue to be purchased for their guarantees and investment characteristics, not their tax preferences. Given these changes, it is perhaps time to abolish the “annuities should never go into an IRA” rule and recognize that it has become more a myth and remnant of old than proper advice in today’s environment.