We have been focusing quite a bit in our articles as of late on the subject of retirement accounts.
There seems to be lifted consumer confidence in the last few months and with the proposed tax cuts in the United States, people will have more money on their hands.
The good news is that people are more interested (at least from our customer emails) in taking those tax savings and rather than just spending the money they prefer to put that money away for retirement. This is wonderful to hear and we are happy to research anything that our clients are interested in.
A 408b is a type of annuity that can be placed in an Individual Retirement Account (IRA) and we are going to spend the rest of this brief article introducing you to the 408b annuity.
What is a 408b?
Above is a very lengthy video about 408b’s. Feel free to watch it if you have 45 minutes but if not let’s just get on with it shall we?
As we have mentioned in a previous post, annuities are contracts sold by banks, insurance companies, or sometimes individuals where the seller of the annuity guarantees to the buyer a one-time payment or recurring payments over a predetermined period of time.
The difference between this type of annuity (408b) is that it is primarily held in an IRA. Now, why is this a decent idea? Take a standard annuity where the buyer gets paid out a certain amount of premium a year. Those premium payments are taxed. However having a 408b account inside of an IRA allows the premium payments to grow tax-free as they are not taxed until the money is withdrawn from the account.
Benefits of a 408b Account
Well, this should be pretty obvious right now…instead of getting taxed on premium payments, the buyer of this annuity that places it inside of their IRA can allow those payments to grow tax-free. Any interest, dividends, or pure gains from those premium payments will all be able to grow tax-free. Since this is done in an IRA most of the time, withdrawals from the account when the owner of the IRA is over 59 and a half are taxed as income. Fortunately, most believe they will be in a lower tax bracket when they begin to withdraw from their retirement accounts.
Downside of 408b Accounts
If we are going to purchase a 408b account inside of an IRA, we are also subject to the same deductions that come with an IRA. Currently, one can deduct $5,500 a year on contributions to an IRA and any payments towards a 408b account are subject to those same restrictions. Some people may see this as a downside because this restricts our ability to save money with this specific type of annuity. On top of this, those premiums received from the annuity will not be available to the buyer until they withdraw funds from the account,
Things to Think About
Like all other types of IRA’s, there is an additional 10% penalty on all withdrawals for those who take some of their money out before they are 59 and a half years old. Let’s imagine we are 50 years old and we would like to take out $10,000 from this IRA that has the 408b annuity in it. We can also assume a 30% tax rate for this example. We see the $10,000 as income which is taxed at 30% but because we are not yet 59 and a half we have another 10$ added on top of that. Rather than taking home $7,000 we end up taking home just $6,000 because of the penalty.
We will close this article the same way that we do every article where we speak about retirement accounts. Yes, the rules the regulators have created where all purchases must be 100% cash secured does make it challenging to mimic the returns or an individual non-retirement account. That being said, allowing gains to grow tax-free is a tremendous advantage and a majority of the population will be in a lower tax bracket when they choose to take money out of their retirement accounts as compared to when they are in the twilight of their careers. Because of this, we recommend maxing out as many retirement accounts as possible.