401k Rollover: Should You Choose an IUL or Annuity?
401k rollover decisions are important when changing jobs or preparing for retirement. Depending on your former employer’s plan, you may be able to leave your savings where they are, move the money to a new employer’s plan, complete a direct rollover into an individual retirement account or take a taxable distribution.
You may also receive recommendations involving an annuity or indexed universal life insurance. Although annuities and IUL policies are issued by insurance companies, they are different products governed by different rules. They should not be treated as interchangeable destinations for retirement money.
A properly structured 401k rollover can generally move eligible retirement money into another employer plan or an IRA without creating current taxable income. An IRA can hold investments or, when applicable requirements are satisfied, be established as an individual retirement annuity.
An indexed universal life policy is different. An IUL is permanent life insurance, not an eligible retirement account. A 401(k) generally cannot be transferred directly into an IUL while preserving the money’s tax-deferred status.
Someone could take a distribution from a 401(k), pay the required taxes and then use part of the remaining money to purchase life insurance. However, that is not a tax-free 401k rollover into an IUL. It is a retirement-plan distribution followed by a separate life-insurance purchase.
Understanding this distinction before authorizing a 401k rollover can help prevent unexpected taxes, penalties and loss of retirement savings.
Why Consider a 401k Rollover?
People commonly consider a 401k rollover after leaving an employer, retiring or trying to consolidate multiple retirement accounts.
According to the U.S. Department of Labor, someone leaving an employer may have several choices:
- Receive a lump-sum distribution
- Transfer the balance to a new employer plan that accepts rollovers
- Complete a rollover into an IRA
- In some cases, leave the account in the former employer’s plan
The right 401k rollover decision depends on more than investment performance. Important considerations include:
- Investment choices and expenses
- Withdrawal flexibility
- Retirement-income needs
- Beneficiary objectives
- Access to professional guidance
- Loan availability
- Legal and creditor protections
- Required minimum distributions
- Age and employment status
- Pre-tax, Roth and after-tax balances
- Need for insurance guarantees
- Access to liquid savings
A 401k rollover should begin with the participant’s complete financial situation—not an assumption that a particular investment or insurance product must be purchased.
Four 401k Rollover Choices
Before completing a 401k rollover, compare all available alternatives.
Leave the money in the former employer’s plan
Instead of completing a 401k rollover, some former employees may keep their money in the former employer’s plan.
This may preserve access to institutional investments, familiar account tools and potentially competitive expenses. Possible disadvantages include limited investment choices, withdrawal restrictions and the inconvenience of managing several employer accounts.
Review the plan’s fees, investments and distribution provisions before leaving the money in place.
Transfer it to a new employer’s plan
If a new employer’s plan accepts a 401k rollover, consolidating the accounts may make retirement savings easier to manage.
The new plan might provide institutional investments, plan-level protections or loan access. However, not every plan accepts incoming rollovers. Its expenses and investment choices may also be better or worse than the alternatives.
Complete a direct rollover into an IRA
A 401k rollover into an IRA may provide a wider range of investments and greater control over beneficiaries and withdrawals.
An IRA may also hold a qualifying annuity contract when it is properly established as an individual retirement annuity. The insurer or custodian must be able to accept and correctly report qualified retirement money.
Moving into an IRA can mean giving up certain employer-plan benefits. Compare expenses, investments, withdrawal rules and legal protections before proceeding.
Take a cash distribution
Taking the money directly is generally the most tax-sensitive choice.
The IRS rollover guidance explains that an eligible distribution paid directly to a participant is generally subject to mandatory 20% federal income-tax withholding.
The taxable portion not completed as an eligible 401k rollover is generally included in income. If the participant is younger than age 59½, an additional 10% early-distribution tax may apply unless an exception is available.
State taxes may also apply.
Direct 401k Rollover Versus Receiving a Check
With a direct 401k rollover, the plan administrator sends the money directly to an eligible retirement plan or IRA. A check may sometimes be delivered to the participant, but it is made payable to the receiving custodian.
Federal income tax generally is not withheld from a properly completed direct rollover.
If the distribution is paid directly to you, the plan generally must withhold 20% of its taxable portion. You ordinarily have 60 days to complete an eligible rollover, but you would need to replace the withheld amount from other funds to transfer the entire balance.
For example, suppose someone requests a $100,000 distribution. The plan may withhold $20,000 and send the participant $80,000.
Depositing only $80,000 into an eligible IRA could leave the withheld $20,000 treated as a distribution. That amount may be taxable and could face an additional early-distribution tax.
A direct 401k rollover can help preserve tax deferral and avoid mandatory withholding. Confirm the instructions with both the distributing plan and receiving custodian before moving the money.
Can a 401k Rollover Go Into an IUL?
An IUL is a permanent life-insurance policy. It may provide a death benefit and accumulate cash value through an interest-crediting formula connected partly to an external market index.
An IUL is not an IRA or eligible retirement plan. It generally cannot accept a direct tax-free 401k rollover.
The phrase “rolling a 401(k) into an IUL” can therefore be misleading. The transaction may actually involve:
- Taking a distribution from the 401(k)
- Recognizing taxable income on the amount not transferred to an eligible account
- Possibly paying an additional 10% early-distribution tax
- Using part of the after-tax proceeds to pay life-insurance premiums
These are separate transactions—not a direct 401k rollover—and consist of a retirement-plan distribution followed by a life-insurance purchase.
Before using retirement money to purchase an IUL, obtain a written explanation of:
- Whether the distribution will be taxable
- How much tax and withholding may apply
- Whether an early-distribution tax may apply
- How much money will remain after taxes
- How future premiums will be funded
- What happens if premiums are reduced
- How the transaction affects retirement income
- Which alternatives were considered
A qualified tax professional should review the transaction before the distribution is authorized.
Could an IUL Still Be Appropriate?
Although an IUL cannot generally receive a direct 401k rollover, it may be evaluated separately when someone needs permanent life insurance and has sufficient non-retirement cash flow.
An IUL may provide:
- Permanent death-benefit potential
- Cash-value accumulation
- Index-linked interest-crediting choices
- A floor within the crediting formula
- Potential access through withdrawals or policy loans
These features do not make an IUL risk-free.
Policy expenses are deducted from cash value. Caps, participation rates and spreads may limit credited interest. Insurance costs may increase, and nonguaranteed terms can change within contractual limits.
A 0% index-crediting floor does not mean the cash value cannot decline. Policy charges continue even when the index credit is zero.
Withdrawals and loans generally reduce the policy’s value and death benefit. Loans accrue interest. Inadequate premiums, excessive borrowing or lower-than-illustrated credits can cause the policy to lapse.
Following a 401k rollover decision, an IUL should be evaluated separately and treated as life insurance first. It should not be presented as an IRA substitute or a method of avoiding retirement-plan distribution rules.
Learn more through the Gibbs Insurance overview of life insurance options.
Can a 401k Rollover Go Into an Annuity?
A 401k rollover may be completed into an IRA annuity when the contract is properly structured to accept qualified retirement money.
An insurer may offer an individual retirement annuity that qualifies as an IRA. If the transaction satisfies applicable requirements, eligible money may be transferred directly into the IRA annuity without current taxation.
The receiving contract’s registration matters when a 401k rollover is directed into an annuity. A nonqualified annuity purchased with after-tax money is not automatically an eligible rollover destination.
Before proceeding, confirm that:
- The annuity will be registered as an eligible IRA
- The insurer or custodian can accept a direct transfer
- The distributing plan recognizes the receiving account
- Pre-tax, Roth and after-tax balances will be handled correctly
- The transaction will be reported as a rollover
The IRS explains in Publication 590-A that eligible distributions from an employer plan may generally be rolled into a traditional IRA. It also recognizes qualifying individual retirement annuities.
Not every distribution is eligible. Required minimum distributions, hardship distributions and certain periodic payments may receive different treatment.
Qualified and Nonqualified Annuities
The word “annuity” does not determine whether a 401k rollover preserves tax deferral.
A qualified annuity is held within a tax-qualified arrangement, such as an IRA. The money retains its retirement-account character and remains subject to IRA rules.
A nonqualified annuity is generally purchased outside an IRA with after-tax money. Sending pre-tax 401(k) money into an ordinary nonqualified annuity could cause the transaction to be treated as a taxable distribution.
Ask how the receiving annuity will be titled and reported before completing the 401k rollover.
Annuity Choices for a 401k Rollover
Several annuity types may be available within an IRA.
Fixed annuity
A fixed annuity credits interest according to the insurer’s contract. It may provide relatively predictable accumulation, subject to guarantees and renewal-rate provisions.
Fixed indexed annuity
A fixed indexed annuity credits interest through a formula connected partly to an external index. The owner is not directly invested in that index.
Caps, participation rates and spreads may limit interest credits. A negative index result may produce a zero credit, while rider fees can still reduce value.
Variable annuity
A variable annuity offers investment choices that can rise or fall with market performance. It may include investment expenses, administrative costs, mortality and expense charges, and rider fees.
Income annuity
An immediate or deferred income annuity may convert a premium into payments for a stated period, for life or for joint lives. Income guarantees may address longevity risk, but access to the premium can be limited.
When a 401k rollover funds an IRA annuity, guarantees depend on the issuing insurer’s claims-paying ability.
Potential Benefits of an Annuity Rollover
A 401k rollover into an IRA annuity may be considered when someone wants to add insurance guarantees or convert part of retirement savings into predictable income.
Potential objectives include:
- Creating income for life
- Reducing concern about outliving assets
- Protecting part of a portfolio from direct market losses
- Establishing a future income floor
- Coordinating payments with Social Security or a pension
- Simplifying part of a retirement-income strategy
- Adding optional living or death-benefit features
The NAIC Buyer’s Guide to Fixed Deferred Annuities explains withdrawals, annuitization, surrender charges and optional living benefits.
An annuity inside an IRA does not create additional tax deferral beyond the IRA’s existing tax treatment. The reason to use an annuity for a 401k rollover should be its guarantees and income features—not merely tax deferral.
Risks of Using an Annuity
An annuity is not automatically appropriate because it can accept a 401k rollover.
Surrender charges and liquidity
Many deferred annuities impose surrender charges on withdrawals exceeding a permitted amount during an initial period. Some contracts restrict access to money, and annuitization may be irrevocable.
Fees and riders
Income and death-benefit riders may involve annual charges. Variable annuities can include several layers of expenses. Request a complete fee disclosure.
Inflation
A fixed payment may lose purchasing power. Increasing-income options may help, but they can reduce initial income or create other trade-offs.
Insurer risk
Guarantees depend on the insurer’s claims-paying ability.
Opportunity cost
Placing too much retirement money into an annuity may reduce investment flexibility, growth potential and access to capital.
Continuing retirement rules
An IRA annuity remains subject to applicable tax and required minimum distribution rules.
The NAIC advises consumers to understand surrender charges, expenses and free-look provisions. See What You Should Know Before You Buy an Annuity.
These limitations should be considered whenever a 401k rollover includes an annuity.
Comparing an IRA Annuity With an IUL
A 401k rollover into an IRA annuity and an IUL purchase are fundamentally different transactions.
An IRA annuity may:
- Accept eligible rollover money
- Preserve retirement-account tax treatment
- Provide accumulation or income features
- Offer contractual guarantees
- Remain subject to IRA distribution rules
An IUL may:
- Provide permanent life-insurance protection
- Accumulate cash value
- Offer index-linked crediting choices
- Allow potential access through withdrawals and loans
- Require premiums and policy monitoring
- Be funded separately from a rollover
An annuity generally addresses the risk of living a long time and exhausting retirement assets. Life insurance is primarily intended to provide a death benefit.
After evaluating a 401k rollover, someone may determine that an annuity, an IUL, both products or neither fits the broader financial strategy.
A Hypothetical 401k Rollover Example
Consider Robert, age 61, who recently retired with $600,000 in a former employer’s 401(k). This is a hypothetical educational example.
Robert wants income, liquidity and a legacy for his children. An insurance professional discusses an IRA annuity and an IUL.
Robert’s choices may include:
- Leaving some money in the former plan
- Completing a 401k rollover into an IRA
- Using an IRA annuity for part of the transfer
- Keeping liquid investments for emergencies
- Evaluating an IUL separately
- Using non-retirement money for insurance premiums
- Reviewing taxes before taking a distribution
Suppose Robert completes a direct 401k rollover of part of the balance into an IRA annuity. When properly structured, the transaction may preserve tax deferral.
If Robert instead takes $100,000 from his plan and uses it to pay IUL premiums, the taxable portion not transferred into an eligible account may be included in his income.
A 401k rollover into an IRA annuity and a separate IUL purchase must be analyzed as distinct transactions.
Questions Before a 401k Rollover
Before authorizing a 401k rollover, ask:
- Can I leave the money in the former plan?
- Will my new employer’s plan accept the transfer?
- What fees and investments apply?
- Is the proposed transaction a direct rollover?
- Will federal or state tax be withheld?
- Is the receiving account an eligible IRA?
- Will an annuity be registered as an IRA annuity?
- What surrender charges and annual expenses apply?
- Which guarantees are contractual?
- How much money will remain liquid?
- How will inflation be addressed?
- How will required minimum distributions be handled?
- What compensation will the professional receive?
- Which alternatives were considered?
- Have tax and financial professionals reviewed the transaction?
If an IUL is proposed, ask why permanent insurance is needed, how premiums will be funded, what taxes the distribution could create and what might cause the policy to lapse.
Planning a Responsible 401k Rollover
The best 401k rollover is not necessarily the product with the most attractive illustration. The decision should reflect income needs, tax circumstances, risk tolerance, liquidity, insurance needs and legacy objectives.
A careful process includes:
- Reviewing the existing plan
- Identifying pre-tax, Roth and after-tax balances
- Comparing the former plan, new plan and IRA
- Identifying liquidity needs
- Estimating retirement income
- Reviewing Social Security and pension choices
- Determining appropriate market exposure
- Evaluating insurance guarantees
- Comparing annuity and non-annuity alternatives
- Reviewing taxes before authorizing the transaction
A 401k rollover should be deliberate. Do not allow urgency, promotional bonuses or limited-time rates to replace careful analysis.
The Bottom Line
A 401k rollover requires understanding both the product being recommended and the legal destination of the retirement money.
A properly structured direct 401k rollover may move eligible money into another employer plan, a traditional IRA or an IRA annuity without current taxation.
An IUL is not an eligible retirement account and generally cannot receive a direct tax-free 401k rollover. Purchasing an IUL with a retirement-plan distribution may create taxable income and possibly an additional early-distribution tax.
An IUL may still be evaluated separately when someone needs permanent life insurance, has adequate resources for premiums and understands the policy’s risks.
An annuity may provide protected accumulation or lifetime income, but it can also involve surrender charges, limited liquidity, expenses and insurer risk.
Before completing a 401k rollover, compare every alternative and consult qualified tax, retirement and insurance professionals.
Visit the Gibbs Insurance life-insurance information page or learn about Jay Cohen’s insurance experience.
You can also contact Gibbs Insurance & Financial Services to request an educational review of your insurance and retirement-income objectives.
This article provides general educational information and is not individualized investment, insurance, tax or legal advice. Insurance and annuity guarantees depend on the issuing insurer’s claims-paying ability. Consult qualified professionals before authorizing a distribution, rollover, annuity purchase or life-insurance transaction.