Taxation of IRA Annuities
IRA annuities are one option you have when deciding how to save money for retirement. IRA annuities are annuities that are purchased inside of IRA accounts. These annuities function like any other annuity with the exception that they also carry the benefits of IRA accounts. Make sure you understand the tax implications of IRA annuities before you buy into this type of arrangement.
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Types
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The two types of annuities available to you inside of an IRA are immediate annuities and deferred annuities. An immediate annuity inside of an IRA is typically purchased with existing savings in the IRA due to the contribution limits of the IRA. Deferred annuities are set up as a long-term savings inside of an IRA account.
Significance
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The significance of an immediate annuity is that it provides you with a pension income. The immediate annuity payment may be scheduled for a set number of years, or you can elect to have the income payments continue for your entire life. The payments may be transferred to a beneficiary when you die, or they can be stopped at your death -- the choice is yours.
A deferred annuity may be converted to immediate annuity payments or held in the IRA beyond your retirement age. The deferred annuity grows at interest. The interest is determined by the insurance company's fixed interest account or mutual funds inside of the annuity account. Both types of annuities are taxed at ordinary income tax rates in traditional IRA accounts.
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Benefits
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The benefit of income taxation on immediate annuities is that most of the payment you receive from the fixed annuity represents a return of your principal amount. A small amount of the payment represents interest. Only the interest is considered to be taxable as investment income. The benefit of the deferred annuity is that interest is only taxed when you withdraw the money from the annuity account.
Misconceptions
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A common misconception is that the taxation of IRA annuities is the same, regardless of the annuity. However, Roth IRA annuities are not subject to income tax. Roth IRA annuities, unlike traditional IRAs are income tax free.
Considerations
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Consider using a Roth IRA annuity if you anticipate income tax rates to rise in the future. The Roth IRA annuity will avoid the effect of higher taxes in the future. If you think tax rates will be lower in the future, use a traditional IRA annuity since the traditional IRA allows pretax contributions into the annuity to help grow a larger total retirement savings.
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