Individual retirement accounts allow you almost complete control over how the money inside the IRA is invested, and that includes the option of investing the money in an annuity. However, using annuities inside an IRA makes withdrawals more complicated because you have to worry about both the annuity withdrawal rules and the Internal Revenue Service's rules on distributions from IRAs.
The Internal Revenue Service rules let you remove money from your IRA whenever you want -- you just owe an extra 10 percent penalty on the taxable portion if the distribution isn't qualified. If you're taking money out of a traditional IRA at 85, you're easily qualified because the only requirement for traditional IRAs is that you take the withdrawal after you turn 59 1/2 years old. Roth IRAs, on the other hand, also require that you've had a Roth IRA open for at least five years before your withdrawals are qualified. So, if you haven't had the account for five years, the distributions won't be qualified withdrawals and the taxable portion of your withdrawals will be hit with the 10 percent penalty.
Just because the IRS rules allow you to take a penalty-free withdrawal from your annuity doesn't mean you can access the money. The withdrawal rules vary from annuity to annuity depending on your financial institution and the type of annuity you hold in your IRA. For example, Vanguard warns that income annuities can only be canceled under limited circumstances and the variable annuities may charge a surrender fee depending on how long you've held them. So, you need to consult your annuity terms to see if you can cash out and, if so, how much it will cost you.
If you're withdrawing from a traditional IRA annuity, your withdrawals from the plan are treated entirely as taxable income unless you made nondeductible contributions -- putting in money and not deducting it on your taxes. In that case, a prorated portion of your distribution comes out tax-free. For Roth IRA annuities, you get the entire amount out tax-free as long as it's a qualified withdrawal. If not, you get all your contributions to the Roth IRA out tax-free before taking out any earnings, which are then counted as taxable income.
The taxable portion of your distributions from an IRA annuity plan counts as ordinary income, which means it's taxed at the same rates as your regular income, like salary or interest income. As of 2013, that means it's taxed at a rate up to 39.6 percent. However, since it's a distribution from an IRA, it won't be hit with the additional 3.8 percent net investment income tax no matter how much money you make.