How to Roll Over Your 401(k) Into An Annuity

When you leave a job where you had a 401(k), it’s important to understand your options for rolling over your tax-advantaged plan. Many choose to roll their money into a new 401(k) or an IRA, but an annuity is another viable option. Cashing out is also a possibility, but it can result in significant taxes. Here’s why an annuity may be ideal for your 401(k) rollover and how to conduct the process.

For more help with a 401(k) rollover, consider working with a financial advisor.

401(k) Rollover Definition

A 401(k) rollover is the process of transferring the money from a 401(k) plan into another retirement savings account. This consolidation can help simplify your retirement savings. For instance, when you start a new job that offers a 401(k), you can move over your old 401(k) funds into your new employer’s plan.

You might also use a 401(k) rollover if you leave a job for another that doesn’t offer a 401(k). In this case, you might roll over your funds into an individual retirement account (IRA) or an annuity. 

There are two ways to roll over your 401(k) into a new retirement account or annuity:

• Direct 401(k) rollover: With a direct rollover, you provide your new retirement account information to the manager of your current plan. Then, the manager sends the funds to your new account.
• Indirect 401(k) rollover: An indirect rollover means liquidating your account. You’ll receive a check in the mail and must deposit the funds into a new account within 60 days, or pay income taxes plus a 10% early withdrawal penalty if you’re under the age of 59 ½ (or 55 if you’re retired).

How to Roll Your 401(k) Into an Annuity

Rolling your 401(k) into an annuity can create a stream of guaranteed payments throughout your retirement years. This financial strategy requires careful consideration of your long-term goals and an understanding of the process involved.

Here’s how to handle it:

1. Make a plan: Consider discussing your rollover strategy with a professional, such as a financial advisor, to find the annuity that’s most suited to your unique situation. In addition, they can oversee the rollover to ensure everything is correct.
2. Choose an annuity: As with any financial decision, it’s best to shop around. Talk to multiple annuity companies and get the details on each offer. Then, you can compare each plan’s structure and fees. Also, look into how financially stable each company is.
3. Communicate with your chosen company: Once you make your pick, communicate with the annuity company. Let them know that you want to purchase a contract and roll over funds from another retirement plan. Your financial advisor can also facilitate this communication.
4. Send instructions to your plan administrator: Once you’ve acquired the annuity and filled out the necessary paperwork, instruct your 401(k) administrator to execute the rollover. A direct transfer is the easiest way to complete the process.

Reasons to Roll Your 401(k) Into an Annuity

Although you can roll your 401(k) into numerous account types, an annuity offers specific advantages. You might consider a rollover into an annuity for the following reasons: 

1. Reliable Income

An annuity provides steady income regardless of economic changes and stock market performance. For example, a $1 million annuity could potentially provide about $70,000 in annual income for the rest of your life. On the other hand, $1 million in a 401(k) or IRA would only last as long as the account produces investment income and your withdrawals don’t drain the fund.

For instance, say you expect $70,000 of annual income from your retirement plan, but stock market volatility causes your portfolio to dip by 20%. Your $1 million nest egg could shrink to $800,000 overnight. After you withdrew $70,000 for that year’s expenses, you’d be left with just $730,000 in your account.

If the economy were to continue struggling, you might drain your account within several years, leaving you without an income stream. An annuity generally avoids this possibility because your income doesn’t depend on the stock market. Instead, it comes from the company holding your policy.

2. Fewer Longevity Complications

Likewise, a 401(k) can run out of funds if you live long enough. For instance, you might plan to live for 30 years after retiring at 62. However, if you’re going strong at 90, there’s a solid chance your retirement account could no longer keep up with the increased cost of living. 

In this scenario, you could run out of money even if you maintain the same lifestyle for longer than you intended your 401(k) account to last. With an annuity, you’d continue receiving payments year after year, no matter how long you live.

3. More Tailored Plan

Traditional retirement plans usually have cut-and-dried structures. Annuities, in contrast, offer modifications, known as riders, that you can add to suit your situation. For example, you might choose to preempt inflation with an inflation adjustment rider, which raises your income by a small percentage each year.

4. Longer Potential Tax Deferral

You can use a qualified longevity annuity contract (QLAC) to move part of your 401(k) into an arrangement that postpones required minimum distributions and taxes on those funds until age 85. Because funds used to purchase a QLAC are excluded from your RMD calculations, this strategy can help lower taxable income during your 70s. The deferred payments then begin later in life, providing income stability while extending the tax-deferred growth of your retirement savings. 

However, this may only be a viable strategy if you have enough income from other assets, since you won’t be receiving annuity payments immediately. Also, QLACs are subject to annual contribution limits ($210,000 in 2025). 

Find out your next required minimum distribution in just a few steps. SmartAsset’s RMD Calculator helps you plan your withdrawals and anticipate your tax impact.

401(k) Rollover Rules

There are many rules you need to understand and pay attention to if you roll over your 401(k). Here are some essential rules to keep in mind:

• You have 60 days to deposit the money into a new retirement account if you conduct an indirect rollover. Otherwise, you’ll incur steep financial penalties.
• If you roll a 401(k) into an IRA, you can’t make a rollover from the IRA into yet another account until one year has passed.
• Your 401(k) rollover doesn’t count toward traditional IRA contribution limits. However, it will count toward your modified adjusted gross income (MAGI), which can reduce your Roth IRA contribution limit.
• You can roll over a portion of your 401(k) and take the remainder as a payout. However, your payout is subject to income taxes. Plus, if you’re younger than 59 ½, you’ll pay a 10% early withdrawal penalty. This age limit is reduced to 55 if you’re already retired.
• You typically can retain your 401(k) even if you leave your old job. This option might be best if your new job doesn’t offer a retirement plan.
• If your 401(k) has less than $5,000 in it and you leave your job, you must instruct your plan administrator to keep your plan going. Otherwise, they might liquidate your account or roll it into an IRA without your approval.
• If your 401(k) has less than a $1,000 balance, your administrator can liquidate your account and send you a check.
• Keeping company stock in the original 401(k) is generally recommended. If you roll it over, you’ll be liable for net unrealized appreciation. Holding the stock in the same 401(k) will help you receive optimal value from the stock when you decide to liquidate.

Risks of Rolling Your 401(k) Into an Annuity

While annuities can provide valuable income guarantees for retirees, they come with significant trade-offs that should be carefully evaluated, including: 

• Potentially high fees: Annuities can have high fees, especially if you add multiple riders.
• Surrender charges: Annuities have what’s called an annuitization phase during which withdrawals are penalized. You usually must wait at least seven years before moving money out of the account. Otherwise, you’ll pay surrender charges.
• Death benefit not automatic: An annuity generally won’t pay a death benefit to your beneficiary if you don’t have a specific rider. Generally, the insurance company absorbs the money in your account upon your death.
• Comparatively lower growth rates: Annuities usually have lower growth rates than other investment accounts. Therefore, an annuity will likely take longer to reach a $1 million balance than a stock portfolio.

401(k) Rollover Tax Consequences

A direct 401(k) rollover typically doesn’t have tax consequences. You don’t touch the funds at any point, and instead, plan administrators handle the transfer.

That said, there is the possibility of tax consequences with an indirect rollover. If you don’t finish the rollover within the allotted 60 days, the government considers the money a withdrawal and will charge income taxes accordingly. In addition, you’ll pay early withdrawal penalties if you’re under age 59 ½ (under 55 if you’re retired). Because indirect rollovers don’t always go as planned, your plan administrator may withhold 20% of your 401(k) payout for tax purposes if needed.

Also note that matching contributions within a Roth 401(k) may have unique tax consequences when rolling one over. Prior to the passage of the SECURE 2.0 Act, employer matching contributions were made on a pre-tax basis. Therefore, your rollover from a Roth 401(k) must account for both Roth and traditional 401(k) funds. However, the law allows employers to make matching after-tax contributions directly into the employee’s Roth account. 

Best Practices for Rolling Over a 401(k) Into an Annuity

If you’re considering rolling your 401(k) into an annuity, follow these best practices to optimize your finances. 

Understand Annuity Types 

Annuities come in fixed, fixed-indexed and variable varieties. Fixed annuities earn a low interest rate, can guarantee payments for life and won’t suffer capital losses. Meanwhile, fixed-indexed and variable annuities tend to have higher earnings because they tie gains to stocks and other assets. However, these annuities might cap gains when the stock market does well or lose value when it dips. So, a fixed annuity may be the most reliable option.

Postpone Payments to Increase Income

Like Social Security, your annuity payments usually increase if you delay taking them. For instance, buying a $1 million deferred annuity at age 55 and waiting five years to start collecting payments may create an annual income of about $90,000. However, buying the same annuity and waiting 20 years for your first payment could increase your annual income to over $200,000.

Don’t Overfund the Annuity

Annuities have specific funding thresholds that must be met before distributions begin. For example, your annuity might require $500,000 before you can withdraw payments. That said, contributing any amount over this target doesn’t serve a purpose.

Bottom Line

An annuity may be worth considering in a 401(k) rollover, especially if you won’t have access to another 401(k). Annuities offer guaranteed payments throughout the rest of your life, though they can also have high fees and no death benefits. Before initiating a rollover, it’s smart to have a well-laid plan in place and to have thoroughly reviewed your options. 

Tips for Rolling a 401(k) Into an Annuity

• A financial advisor can help you make the best rollover choices. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• You can delay Social Security payments just like annuity distributions. Doing so can strengthen your financial position in retirement. Here’s why delaying Social Security is more lucrative than ever.

Photo credit: ©iStock.com/designer491, ©iStock.com/Delmaine Donson, ©iStock.com/Eleganza