What Is an Individual Retirement Annuity?

An individual retirement annuity is a retirement investment vehicle similar to an IRA except that it must involve an annuity and is not actively managed. An annuity is a financial product that accumulates funds at an initial stage in order to produce a stream of lifetime income later on.

Individual retirement annuities have the same contribution limits, tax advantages and catch-up provisions as an individual retirement account (IRA). They must be issued in the owner's name, and only the annuity owner or their surviving beneficiaries are eligible to receive benefits from the contract.

The Basics of an Individual Retirement Annuity

Individual retirement annuity contracts are essentially tax-deferred or pre-tax personal retirement plans. They can be used to generate income in retirement for an annuitant/owner and may be invested in either a fixed annuity or a variable annuity. Annuities are often sold by financial firms or insurance companies.

A number of specific requirements apply to individual retirement annuities. For instance, the owner's entire interest in the annuity must be fully vested, and the owner is not allowed to transfer any of the balance to another person (though a beneficiary may be named). This type of investment account must allow for flexible premiums, and annual contributions are capped at a specified maximum, which is $6,000 as of 2019 (ages 49 and under) and $7,000 for those ages 50 and older ($1,000 higher due to a catch-up contribution allowance). These amounts are unchanged in 2020. Distributions from this type of annuity must be made before April 1 of the year in which the owner reaches the age of 70-1/2.

Key Takeaways

  • An individual retirement annuity is an annuity purchased with the intent of generating lifetime retirement income.
  • A retirement annuity placed in a traditional IRA can use pre-tax dollars to fund it, while cash flows generated later are subject to income tax.
  • When placed in a Roth IRA, after-tax dollars are used to fund it and income is generated tax-free.

Individual Retirement Annuity vs. IRA

Individual retirement annuities, like individual retirement accounts, are available in the same varieties: traditional (both deductible and non-deductible) and Roth. They differ in how they are funded, how withdrawals are taxed and what they may invest in. The biggest difference between individual retirement annuities and IRAs is that the latter is open to whatever investments are offered by an account custodian, whereas the former is limited to fixed and variable annuities only.

Often times, a retirement annuity can be placed inside of a retirement account. If the annuity is placed in a traditional IRA, cash flows received will be subject to income tax at the tax rate you are subject to at the time it is received. If the annuity, however, is in a Roth IRA (subject to contribution limits), where it is funded with after-tax dollars, then the cash flows received from the annuity will be delivered income-tax-free.

Individual Retirement Annuity Advantages

An individual retirement annuity can help individuals in two main ways: Those who are not eligible for an employee-sponsored retirement savings and investment plan can use them to generate income in retirement. Also, they may offer advantages in the deductibility of an initial contribution amount that some individuals would not otherwise have access to because of their income level. Some other advantages of individual retirement annuities include:

  • Funds are always available to the annuity owner.
  • They may be created and funded independently of an employer sponsor.
  • Taxes on contributions and earnings are not due until retirement/withdrawal.

Rules governing individual retirement annuities may be found in Title 26, Subsection 408 of the U.S. Code.