An annuity is an insurance product designed to provide monthly income after retirement. Purchasing a life annuity as part of a retirement investment portfolio can provide a steady income stream of distributions that are not affected by the ups and downs of the market. Variable annuities can offer the deferral of taxes on potential growth until after retirement, a hallmark of qualified private retirement programs.
Qualified retirement benefit annuities are accounts such as a 401(k), 403(b) or individual retirement account, or IRA. Your contributions to these qualified annuity accounts are taken out of pretax dollars from your payroll but are taxed whenever you begin to take distribution after the age of 59 1/2. The premise is that you'll be in a lower tax bracket after retirement, so you'll pay less in taxes on your annuity distributions than you would pay on that income now.
A nonqualified retirement benefit annuity is an investment made using after-tax income. Since you've already paid taxes on the income, you will not be taxed on the distributions of principal that you've made to the account. Any interest earned in the account will be subject to taxation at the time of distribution, but that interest may instead be reinvested and taxes will be deferred.
Contributing to Your Retirement Plan
Tax-deferred contributions to a qualified annuity are limited by the Internal Revenue Service. In 2013 and 2014, the maximum contribution you can make to a traditional or Roth IRA is $5,500 if you're under the age of 50 or $6,500 if you're over the age of 50. One of the advantages of a nonqualified annuity is that there is no limit to the amount of money you can contribute to your retirement annuity plan.
Immediate Fixed and Variable Annuities
An immediate fixed annuity provides a regular, steady distribution payment for life during retirement. After purchase of the annuity, the insurance company takes the risk that the market will fluctuate or you'll live longer than the normal life expectancy. A variable annuity allows you to control the portfolio of investments held within the annuity, so you maintain that possibility of a larger nest egg at the time of retirement. However, you also assume more risk of a market downturn affecting the amounts of your annuity distributions in retirement.
- Charles Schwab: Two Types of Annuities for Retirement Income
- Internal Revenue Service: Retirement Topics -- Contribution Limits
- Edward Jones: Annuity Taxation
- Hyers & Associates: Qualified and Nonqualified Annuity Accounts Explained
- CNN Money: What Is an Annuity?
- North Carolina Department of Revenue: Retirement Benefits Deduction
- Internal Revenue Service: Topic 410 -- Pensions and Annuities
Chris Baylor has been writing about various topics, focusing primarily on woodworking, since 2006. You can see his work in publications such as "Consumer's Digest," where he wrote the 2009 Best Buys for Power Tools and the 2013 Best Buys for Pressure Washers.