401k into an annuity or IRA – Ask the M-Network

By glblguy

ask-the-m-networkThis article is part of the Ask the M-Network series. Helen submitted a question and asked:

Should we put our 401K into Flexible Premium Deferred Variable Annuity, Flexible Premium Deferred Variable annuity or an IRA?

Pinyo from Moolanomy responded:

IRA, period. Actually, this is a good question that deserves further explanation. Deferred annuities allow you to invest tax-deferred for retirement, similar to an IRA. But there is one important difference to recognize. Annuities are insurance products sold by insurance companies, whereas an IRA is an investment account with a special purpose (for retirement) and tax status (tax-deferred). Once you recognize this, you’ll understand why I answered “IRA, period”. Now, let’s look at this further.

The Difference in Cost

First, it will most likely costs you more to buy a deferred annuity as opposed to investing via an IRA account. Why? Because part of your money goes toward your insurance agent’s commission for selling you the product and another portion goes toward the insurance company annually to manage the money for you. There’s no transparency in term of expenses, but I can guarantee you that it’s high because insurance companies are in the business of making money and not doing the best you can to help you meet your retirement investing goal.

With an IRA, you’re paying for trade commissions and funds expenses. The total cost is easily controlled by limiting the number of trades and investing in funds with low expenses. For example, you can keep the overall cost to less than 0.20% per year plus trade commissions by investing in a Vanguard Target Retirement Fund.

The Difference in Investment Flexibility

Second, you have no flexibility to change your investment strategy down the road because the insurance company is controlling everything — all you get is a product with a promise of fixed return. The insurance agent will make the guaranteed return on investment sounds very appealing. But the cost of this guarantee (actually the return is promised, but not guaranteed)) is too high for most people.

On the other hand, you have full control over your investment strategy inside an IRA with access to almost every stocks, mutual funds, and ETFs in existence.

Difference in Investment Protection

Third, the reason I said “promised, but not guaranteed” is because your ability to get back your principal and any interest depends on the insurance company’s ability to pay you back. If your company goes out of business, your ability to recoup your money depends on the Guaranty Association of your state. Different states have different levels of protection, so you’ll have to do your research.

On the other hand, if you purchase traditional bank product (i.e., savings, money market, and cds) inside your IRA account, it’s federally insured by the FDIC. The remaining portion of your investments are protected by Securities Investor Protection Corporation (SIPC).

But I like fixed return offered by annuity

If you still think that the fixed return on deferred annuity is such a great feature, you should consider the alternative of investing in Treasury Inflation-Protected Securities through your IRA account instead. As you become more comfortable and skilled with investing, you can invest beyond fixed income securities. With an IRA, it’s not difficult to build a globally diversified investment account customized to your situation for very little costs.

So, when should you consider deferred annuities?

In my opinion, there’s only one reason why you should consider buying a deferred annuity — that is, if you already exhausted all of your other investment options but still want to invest more in a tax-deferred account. For example, you are already contributing up to the maximum contribution limits for both 401k and IRA, but have a few thousands more to invest. Between the guaranteed return and the tax savings, deferred annuity may offer enough advantage over investing in a non tax-advantage account to overcome the costs.

Other M-Network members said:

The rest of the M-Network all agreed with Pinyo’s reply and since Pinyo covered the topic so thoroughly that had nothing significant to add. To be real honest, investing is not an area I am real knowledgeable on, but I know Pinyo is and he’s passionate about the topic. I would definitely trust his advice in this scenario.

Ok readers, what do you think? Anybody disagree with Pinyo? If you agree, do you have anything additional to ad? Share your thoughts and perspective with Helen by adding a comment!

4 Responses (including trackbacks) to “401k into an annuity or IRA – Ask the M-Network”

  1. MyJourney Says:

    Wow very complete answer, but I feel the answer is premature insofar as you are missing information. However, first thing is first, there is nothing stopping this person from rolling into a 401(k) and then purchasing a partial annuity.

    The information that is missing is the person’s age and risk tolerance. If the “question asker” is 50 and can’t stomach the ups and downs of the market for both emotional and monetary reasons, the annuity is not such a horrible option. I say 50, because most annuities have a 5 to 8 year span of surrender charges.

    Further, many annuities (although most companies are starting to limit the rider) allow for a guaranteed income regardless of what the account does. So if we have a particular person that can’t stand the market’s swings and NEEDS guaranteed income – the question should be – why is the annuity a bad call?

    TIPs are a great vehicle now, because inflation is high, but lets fast forward 10 years and inflation is under control at 1% and you are getting lets call it 2.5% on your TIPs investment for a grand total of 3.5% rather than the annuity which had been growing at 5 to 7% guaranteed (granted that guarantee is only based on the insurance company underwriting the product).

    You can check out the example of when withdrawals can screw you up – http://www.myjourneytomillions.com/articles/an-investment-average-of-10-wont-guarantee-success/

    Just some alternative thoughts from a lowly reader!

  2. frugalscholar Says:

    I may be missing something here–but a 401k is by definition tax-deferred. Hence, you don’t need an IRA, which also offers tax deferral. Ditto, I think, for the variable annuity. That offers tax deferral, but, as with the IRA, there is no need to get that kind of account within an account that is ALREADY and by definition tax deferred.

    I am a teacher, so I may be missing something here. I have a 401k at work. My IRAs–both regular and Roth–are in accounts separate from the 401k.

  3. My Journey Says:


    I think the person asking the question meant “I have a 401(k), AND I am going to roll it out of there.”

    My point about the annuity was that sometimes people use the investment vehicle for benefits OTHER than tax deferral; including but not limited to a floor to losses & Guaranteed income regardless of your account value.