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Dispatches Retired Investor

Retirees Gain by Using Taxable Assets to Purchase Annuities

A study determined that in general it may be more beneficial for retirees to purchase annuities using their taxable savings instead of funds from a traditional iRa or Roth plan.

by Anine Sus | September 2019

A study determined that in general it may be more beneficial for retirees to purchase annuities using their taxable savings instead of funds from a traditional IRA or Roth plan.

Retirees looking to purchase an annuity naturally think it makes the most sense to fund it from a savings account created for retirement spending. However, annuities receive a tax-deferral benefit when purchased with taxable assets, making the issue less clear. A deferred annuity increases the time that taxable investments are able to grow within the annuity product prior to the start of income payments that are subject to taxation.

The study’s authors found strong evidence that investors can benefit from using taxable accounts to purchase annuities, although the outcome varied greatly depending on the type of investor and the type of taxable savings they had. The taxable account became more advantageous at higher tax rates, higher returns and less tax-efficient asset with higher gain realization rates.

However, the researchers noted that an annuity purchased from a taxable account will not provide as much net income after a retiree reaches their expected life expectancy. One solution would be to buy an additional deferred income annuity at longevity age to supplement the lower income.

The study concludes that most higher-tax-bracket retirees with a significant amount of savings should consider using their taxable savings to purchase annuities.

Adding to the body of research on asset location, this study shows that retirees can achieve a higher aftertax income for the same amount of portfolio risk by locating annuity purchases from the most efficient account. Contrary to the conventional view, tax-sheltered assets should be used as a supplement to the annuity bought using taxable assets.

Source: “Should Annuities Be Purchased From Tax-Sheltered Assets?” by David Blanchett and Michael Finke; SSRN, August 2019.

Discussion

Win Schwab from VA posted over 6 years ago:

I assume this study did not consider the strategy of buying a qualified longevity annuity contract (QLAC) within a traditional IRA. 25% or $125,000 of your IRA's, whichever is less can be used. The amount used for the QLAC is not included in the amount used to calculate the RMD. Would using this strategy make a significant difference in the article's conclusions?


Dave G from WA posted over 6 years ago:

It turns out the premium limit for the QLAC is now $130,000. I did not study the article in detail but you can download and read the pdf of the article by clicking on the link in the last sentence. As you will see it clearly at least mentions the QLAC. Personally, I would not buy an annuity inside an IRA if I had a taxable account. I am not convinced the QLAC would actually help you much with taxes as it only postpones them and doesn't really get rid of them. By postponing them it will potentially only make them bigger later. The other underlying principle in this discussion is that the taxable account is the less tax-efficient "wrapper" for holding your assets, so putting a large portion of that into your longevity protection is probably the better choice IMHO.


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