What Is an Individual Retirement Annuity?

An individual retirement annuity combines features of an Individual Retirement Arrangement (IRA) with an annuity contract. This retirement savings vehicle allows funds to grow on a tax-deferred basis, aiming to provide a structured income stream for retirement.

Key Characteristics of an Individual Retirement Annuity

An individual retirement annuity is an insurance contract, distinguishing it from investment vehicles like mutual funds or stocks. This contract is exclusively provided by insurance companies.

While an individual retirement annuity incorporates an annuity contract, it operates under the regulations governing Individual Retirement Arrangements. This includes eligibility criteria and general distribution rules applicable to IRAs. Unlike a standard IRA that can hold diverse investments, an individual retirement annuity is designed to hold only annuity contracts. This highlights its focus on providing a guaranteed income stream rather than broad investment diversification.

The underlying annuity contract can be structured as either a fixed or variable annuity. A fixed annuity provides a guaranteed interest rate, offering predictable growth with reduced risk. Conversely, a variable annuity ties its returns to the performance of underlying investment options, presenting the potential for higher growth but also carrying market-related risk. Both types prioritize tax-deferred growth until payments commence. This structure combines the tax advantages of an IRA with the contractual assurances of an annuity.

Contribution Rules for Individual Retirement Annuity

Individuals must possess earned income to contribute to an individual retirement annuity, such as wages, salaries, tips, or net earnings from self-employment. Income levels can affect the deductibility of contributions to a traditional individual retirement annuity.

Annual contribution limits apply, mirroring those for traditional and Roth IRAs. For 2025, the maximum contribution is $7,000. Individuals aged 50 and older can contribute an additional $1,000, bringing their total annual limit to $8,000.

Contributions can be made directly to the annuity contract within the IRA framework. Funds can also be transferred through rollovers from other qualified retirement plans, such as 401(k)s or other IRAs. For indirect rollovers, individuals have 60 days to reinvest funds into another IRA to avoid taxes and penalties. Indirect IRA-to-IRA rollovers are limited to one per 12-month period.

Tax Rules and Withdrawals

The tax implications of an individual retirement annuity are governed by standard IRA rules. Contributions to a traditional individual retirement annuity may be tax-deductible, reducing an individual’s taxable income. This deductibility can be limited or phased out if the contributor, or their spouse, is covered by a workplace retirement plan and their income exceeds certain thresholds. If neither spouse is covered by a workplace plan, contributions are fully deductible up to the annual limit, regardless of income.

Earnings within the annuity grow tax-deferred, meaning interest, dividends, or capital gains are not taxed annually. Instead, taxes are deferred until funds are withdrawn during retirement. When distributions commence, they are taxed as ordinary income.

Withdrawals made before age 59½ are subject to a 10% early withdrawal penalty, in addition to regular income taxes. Exceptions to this penalty include withdrawals for a first-time home purchase (up to $10,000 lifetime limit), qualified higher education expenses, certain unreimbursed medical expenses exceeding 7.5% of adjusted gross income, or distributions due to permanent disability. Payments received as part of a series of substantially equal periodic payments (SEPPs) based on life expectancy also avoid the early withdrawal penalty.

Required Minimum Distributions (RMDs) must begin once the account holder reaches age 73. The first RMD must be taken by April 1 of the year following the year the individual reaches RMD age. Subsequent RMDs must be taken by December 31 of each year. Failure to take a timely RMD can result in a 25% penalty on the amount that should have been withdrawn, which may be reduced to 10% if corrected promptly.

Understanding Annuitization Options

Annuitization allows for various payout structures during the distribution phase, converting accumulated funds into regular payments. These options involve a contractual agreement for ongoing payments, distinct from simply taking withdrawals.

Annuities can be categorized as immediate or deferred. Immediate annuities begin payments shortly after a lump-sum investment, usually within one year. Deferred annuities allow funds to accumulate over time, with payments commencing at a future date, often in retirement. The choice depends on an individual’s current financial needs and their timeline for income generation.

Common payout choices include:
Fixed period payments, where income is received for a predetermined number of years (e.g., 10 or 20).
Lifetime income stream, guaranteeing payments for the annuitant’s entire life. This can be a single life annuity or a joint and survivor annuity.
Life with period certain option, guaranteeing payments for a minimum period even if the annuitant dies sooner, with remaining payments going to a beneficiary.
A lump-sum withdrawal of the entire principal, though this foregoes the regular payment stream feature.

These options provide flexibility in how retirement income is received, aligning with individual financial planning needs.