Which Types of Annuities Work Inside an IRA

SEP-IRAs and Solo 401(k)s are the retirement accounts that accept annuity contributions, not traditional or Roth IRAs

A traditional IRA or Roth IRA cannot hold an annuity you purchase with new contributions. The IRS treats annuities as investment products, not contribution types. However, a SEP-IRA (Simplified Employee Pension IRA) and a Solo 401(k) can both accept annuity purchases as part of their investment options. The distinction matters because it changes who can open the account and how much they can contribute each year.

If you are self-employed or a small business owner, a SEP-IRA or Solo 401(k) gives you the flexibility to buy an annuity with your retirement savings. If you are an employee with a regular paycheck, your employer's 401(k) plan may also allow annuity investments, but that depends on the plan document your employer chose. A traditional or Roth IRA does not offer this option at all.

Key Takeaways

• SEP-IRAs and Solo 401(k)s permit annuity purchases as investments, while traditional and Roth IRAs do not.
• A SEP-IRA works for self-employed people and small business owners, with contribution limits tied to net self-employment income.
• A Solo 401(k) also serves self-employed individuals and allows both employee and employer contributions, up to higher annual limits than a SEP-IRA.
• Some employer 401(k) plans include annuities as an investment choice, but this depends on what the employer's plan document permits.
• Annuities inside retirement accounts still follow the same withdrawal rules as the account itself — you cannot withdraw before 59½ without a penalty in most cases.

How a SEP-IRA handles annuity contributions

A SEP-IRA is a retirement account designed for self-employed people, freelancers, and small business owners. You can fund it with pre-tax dollars and invest those dollars in almost anything a regular brokerage offers — including annuities. The contribution limit for 2024 is up to 25% of your net self-employment income, with a maximum of $69,000 per year (the limit changes annually). This is higher than a traditional IRA's $7,000 annual limit.

When you buy an annuity inside a SEP-IRA, the annuity contract sits within the IRA wrapper. That means the annuity grows tax-deferred, just as it would outside an IRA, but you also get the SEP-IRA's tax deduction on the contribution itself. You set up a SEP-IRA through a bank, brokerage, or insurance company, and you can open one as late as your tax filing important date (including extensions) for the year you want to contribute.

One important limit: if you have employees, you must contribute the same percentage of salary to their SEP-IRAs as you contribute to your own. This requirement makes SEP-IRAs less attractive for business owners with payroll, which is why many choose a Solo 401(k) instead.

Solo 401(k)s and annuity investments

A Solo 401(k) is a retirement plan for self-employed people with no employees (except a spouse). Like a SEP-IRA, it allows you to invest in annuities. Unlike a SEP-IRA, a Solo 401(k) lets you make both employee deferrals and employer contributions, which can add up to higher annual limits. For 2024, you can contribute up to $69,000 as an employee deferral plus an additional employer contribution based on your net self-employment income, for a combined total up to $69,000.

A Solo 401(k) requires more paperwork than a SEP-IRA — you must adopt a plan document and file Form 5500 if your account balance exceeds $16,000 at year-end. However, the higher contribution limits and the ability to take loans against the account balance make it worth the extra effort for many self-employed people. You can purchase an annuity through the Solo 401(k) and hold it alongside other investments like stocks, bonds, or mutual funds.

You must open and fund a Solo 401(k) by December 31 of the year you want to contribute, though you can file an extension to complete the paperwork. The annuity inside the Solo 401(k) follows the same withdrawal rules as the account — you generally cannot withdraw before 59½ without paying a 10% early withdrawal penalty, plus income tax on the amount withdrawn.

Employer 401(k) plans that include annuities

If you work for an employer that offers a 401(k) plan, that plan may include annuities as one of the investment options available to you. This is entirely up to the employer — some plans offer annuities, others do not. You would choose the annuity from the investment menu when you enroll in the plan or during the annual enrollment period. Your contributions go into the annuity just as they would into a mutual fund or target-date fund.

The advantage of an annuity inside an employer 401(k) is that your contributions are deducted from your paycheck before taxes, and the annuity grows tax-deferred. The disadvantage is that you have no control over which annuity the plan offers — the employer selected it. If you want to know whether your employer's 401(k) includes annuities, check your plan's investment menu or ask your HR or benefits department.

Why traditional and Roth IRAs do not accept annuities

A traditional IRA and a Roth IRA are designed to hold a broad range of investments — stocks, bonds, mutual funds, real estate, and precious metals. However, the IRS does not permit you to purchase a new annuity contract with IRA contributions. The rule exists because annuities are insurance products with their own tax-deferred growth and withdrawal rules, and layering them inside an IRA creates complexity the IRS wanted to avoid.

You can, however, roll an existing annuity into an IRA if you are moving money from an employer plan like a 401(k). This is called a direct rollover. The annuity itself becomes an IRA investment, but you cannot add new contributions to it through the IRA. If you want to buy an annuity with IRA money, you must use a SEP-IRA or Solo 401(k) instead.

Tax treatment of annuities in retirement accounts

An annuity held inside a SEP-IRA, Solo 401(k), or employer 401(k) grows tax-deferred, meaning you do not pay income tax on the gains each year. When you withdraw money from the account after 59½, you pay income tax on the entire withdrawal at your ordinary tax rate. If you withdraw before 59½, you owe a 10% early withdrawal penalty on top of the income tax, with limited exceptions (such as disability or a Roth conversion).

The annuity's own features — such as a may provide income rider or a death benefit — still explore inside the retirement account. However, some features that make sense outside a retirement account, like a Roth conversion option or a tax-free withdrawal provision, may be redundant or unavailable inside an IRA. Before you buy an annuity for a retirement account, ask the insurance company or financial advisor which features are available and which make sense for your situation.

Frequently Asked Questions

Can I move money from a traditional IRA into an annuity?

You cannot purchase a new annuity with traditional IRA contributions. However, you can withdraw money from your traditional IRA and use it to buy an annuity outside the IRA. This triggers income tax on the withdrawal amount in the year you withdraw it. Alternatively, if you have an annuity in an employer 401(k), you can roll it directly into a SEP-IRA or Solo 401(k) and keep it as an annuity.

What happens to an annuity inside a retirement account if I die?

The annuity contract and the retirement account pass to your beneficiary according to the terms you named in the account and the annuity contract itself. If the annuity has a death benefit rider, your beneficiary may receive more than the account balance. Your beneficiary will owe income tax on withdrawals from the retirement account, but the timing and amount depend on the account type and the beneficiary's relationship to you.

Can I take a loan against an annuity in a Solo 401(k)?

A Solo 401(k) allows loans against the total account balance, which may include an annuity. However, not all annuities can be used as loan collateral — some insurance companies restrict this. Check with your annuity provider and your Solo 401(k) plan administrator before assuming you can borrow against the annuity portion of your account.

Do I have to buy an annuity in a SEP-IRA or Solo 401(k)?

No. Both accounts allow annuities as one investment option among many. You can hold stocks, bonds, mutual funds, and other investments in the same account. You are not required to buy an annuity at all — it is straightforward one choice available to you if you want may provide income or other annuity features.