An individual retirement annuity is a product available only in the United States that is classed as a type of individual retirement account (IRA). The main reason for contributing to an individual retirement annuity is to take advantage of the deferred tax benefits on current income while also providing a predictable monthly income during retirement. Annuities are issued by insurance companies to provide long-term income, based on projections of life expectancy, from the capital accumulated over the life of the owner of the retirement annuity, or the annuitant.
An individual retirement annuity can be either immediate or deferred. An immediate annuity provides a steady stream of income for life starting now and is purchased with a one-time lump sum payment. This is a good choice for those who have come into a large cash windfall from an inheritance or some other type of payout, or for people who are already very close to retirement. A deferred annuity is more common, and it is funded through regular monthly contributions from the income of the annuitant.
The payout from a deferred individual retirement annuity can be further divided into fixed or variable payouts. A fixed payout from a deferred individual retirement annuity removes the risk of poor investment returns in the future by opting for a set monthly payout. While this option protects the annuitant from poor returns, it also eliminates the possibility of capitalizing on exceptional gains because of the fixed nature of the return. The variable payout on a deferred individual retirement annuity usually stipulates a minimum payout. It also leaves a portion variable so the annuitant can share in exceptional results, but policyholders must be mindful that it also exposes the payout to the consequences of poor results.
The tax implications of contributing to an individual retirement annuity are one of its main attractions. Contributions that are made to an annuity account are not taxed up to a cap of $5000 US Dollars (USD) since 2008, and the tax payable is deferred until the funds are withdrawn. The long-term nature of annuity contributions means that when the funds are eventually withdrawn, the annuitant is likely to fall under a lower income tax bracket, since little or no income is expected to be made at this point. The net effect is the ability to earn compound interest, on pre-tax money. This occurs when interest is added back to the principal to calculate the interest for the following period.
In addition, the annuitant eventually pays less tax than would have been due had the funds not been deposited to the annuity account because of the lower tax bracket. Individual retirement annuities are a good way to capitalize on existing tax shelters while also guaranteeing an income flow in retirement. Financial advisors are usually able to provide advice on how to incorporate an individual retirement annuity into established retirement portfolios.