Individual Retirement Annuities

What Is an Individual Retirement Annuity?

An individual retirement annuity is an investment vehicle sold by insurance companies that holds fixed and variable annuities. The arrangement offers tax advantages to investors and the opportunity to generate a steady stream of income in retirement.

An individual retirement annuity is similar to an individual retirement account (IRA), but the annuity option holds different types of assets than IRAs. While an IRA can hold virtually any type of asset, including stocks, bonds and alternative investments, an individual retirement annuity can only hold annuities.

Both IRAs and individual retirement annuities are designed to help you save for retirement, and both options can be implemented with traditional and Roth structures, which offer unique tax advantages. Read on to learn more about how these annuities are structured and how the contributions and payouts work.

The individual retirement annuity account type is less like an Individual Retirement Account than it is like an Individual Retirement (Account) CD. The limitations on what investments can be held in the account, in this case only an annuity, make it inflexible for investors who may have changing needs over their life. Since a normal Individual Retirement Account can still hold annuities but also other investments like stocks, bonds, CDs, mutual funds, or ETFs, there isn’t much use for the individual retirement annuity.

Stephen Kates, CFP®Principal Financial Analyst for Annuity.org

Stephen Kates, CFP® is a personal finance expert specializing in financial planning and education. He serves as the Principal Financial Analyst for Annuity.org, where he delves into industry trends to support consumers and financial advisors on wealth management, annuities, retirement planning, and investing.

How Do Individual Retirement Annuities Work?

An individual retirement annuity works like a typical annuity. When you buy an individual retirement annuity, you enter into a financial contract with the insurance company, and you become known as the annuitant. In exchange for an upfront payment, the annuitant will receive a series of income distributions from the insurance company, either immediately or after a specified period of time.

Individual retirement annuities can take the form of a fixed annuity or a variable annuity. A fixed annuity offers a guaranteed rate and/or stream of income with no downside risk, meaning that the payout amount and time period of distribution will remain constant. A variable annuity offers rates and payouts that fluctuate depending on the performance of investments chosen by you. Ultimately, variable annuities offer more upside potential than fixed annuities, but they also come with higher fees and the possibility that you may lose money.

Both types of annuities are generally illiquid, which means that they are not easily convertible into cash, and both types can also be adversely impacted by inflation. Nevertheless, under the right circumstances, either fixed or variable annuities could be used in an individual retirement annuity to bolster your retirement plan.

Traditional and Roth Structures

Like IRAs, individual retirement annuities are available in both traditional and Roth structures. With a traditional structure, your contributions are generally tax-deductible in the year that you make them. Your contributions and any cumulative earnings are not taxed until you withdraw them in retirement. In a Roth structure, your contributions do not receive an up-front tax deduction, but all qualifying withdrawals you make in retirement will be exempt from taxation.

Contribution Limits

Individual retirement annuities have the same contribution limits and catch-up provisions as IRAs. For 2024 the annual contribution limit set by the Internal Revenue Service (IRS) is $7,000 for people under age 50 and $8,000 for people who are aged 50 and over by the end of the year. This limit applies to both traditional and Roth structures and is applied to your contributions.

Distribution Guidelines

For traditional individual retirement annuities and IRAs, withdrawals are subject to income tax at your ordinary income tax rate at the time the withdrawal is made. If you withdraw money before age 59½, a 10% federal tax penalty applies. Additionally, the IRS requires you to begin taking distributions no later than April 1 of the calendar year after the year in which you turn age 73.

For individual retirement annuities and IRAs with a Roth structure, withdrawals of contributions are not subject to income tax. Moreover, withdrawals of any earnings generated on the contributions are not subject to taxation — as long as the withdrawals are taken at least five years after your first contribution, and you have attained the age of 59½. With a Roth vehicle, you as the annuitant are not required to begin taking distributions at any specific age, and mandatory distributions are required only upon your death.

Other Guidelines

In addition to the contribution limits and distribution guidelines covered earlier, individual retirement annuities have a number of other limitations, including those outlined below.

• The underlying annuity must be issued in the owner’s name. However, spousal individual retirement annuities can be created.
• The full value of the annuity must be distributed to the annuitant or surviving beneficiaries. No other parties can receive benefits from the contract.
• Annuity premiums must be flexible to allow the owner to change the payment amounts in response to income fluctuations.

Individual Retirement Annuities vs. IRAs

Individual retirement annuities and IRAs are similar, but they have a few notable differences. The biggest difference relates to the types of assets they hold. Individual retirement annuities only hold fixed and variable annuities, while IRAs can hold virtually any type of asset, including stocks, bonds, alternative investments and even annuities.

As a result of this fundamental difference, the two vehicles have different risk-return profiles. Generally, annuities have lower levels of risk and return — with the potential for guaranteed income. IRAs can be structured to have much higher levels of risk and return, and their profiles can be adjusted relatively easily over time.

Another notable difference relates to fees. Individual retirement annuities often have higher fee structures than IRAs. The discrepancy is particularly noticeable when IRAs are implemented with low-cost, passively managed investments, such as index mutual funds and exchange-traded funds.