This scenario can be trickier, however, if an annuity is part of a retirement account such as an IRA.

Retirement accounts require a minimum distribution (RMD) at age 70 and a half. If the account contains a single premium immediate annuity, say, the annuity assets are exempted from the RMD calculation. But if it’s a variable annuity, which invests in a mutual-fund-like subaccount, “the impact on RMDs depends on whether or not the VA’s income stream has been turned on,” explains Hawley. “Before the VA’s income stream is turned on, the annuity’s value is included when calculating RMDs. Once a VA starts generating income, its value will no longer be used to calculate RMDs.”

For clients who can wait even longer for retirement payments, a different annuity strategy may make the most sense. Dylan Huang, a senior vice president and head of retail annuities at New York Life in New York, suggests, “One way to defer RMDs beyond age 70 and a half is the qualified longevity annuity contract (QLAC).”

Created in 2014, QLACs are longevity annuities that allow clients “to defer a portion of RMDs up until age 85,” he says. Specifically, they enable clients to convert up to $130,000 (as of 2018) from a 401(k) or IRA to a QLAC. “This way, you are also deferring paying taxes on money that you may not need in early retirement,” says Huang.

Tax Implications For Heirs

Another consideration for annuities held in retirement accounts is the effect on heirs. “Annuities do not share the advantage of a step-up in basis for heirs,” says Steve Parrish, co-director of the retirement income center at the American College of Financial Services in King of Prussia, Pa.

He explains that if an heir sells an inherited stock, say, the taxable gain is the difference between the current price and the price when inherited, not the price when the shares were originally purchased. So if it is sold right away, there is no capital gains tax at all. But this step-up in basis does not apply to annuities—unless they’re within a qualified retirement account.

“Current law allows the heir to stretch out receipt of that IRA account over the heir’s life expectancy,” says Parrish, who is based in Des Moines, Iowa. “This has the effect of pushing out taxes over a number of years.” (Note: Congress is currently considering limiting that IRA stretch to 10 years.)

Distributions, however, are taxable. “For heirs, when inheriting retirement accounts or annuities, taxes must be paid on any distributions,” says Laura Parker, an advisor at Sage Rutty & Co. in Rochester, N.Y.

Know Your Annuities