An annuity is an insurance contract that provides periodic payments (fixed or variable) for life or for a defined period of time. Annuity earnings are tax-deferred. Unlike 401k or traditional IRA, annuities typically do not have a limit on how much you can invest each year. However, because of the typical sales and insurance charges occurred with annuities, it might be more efficient to invest in IRA. However, if you have already maxed out your contributions to other tax-deferred or tax-free accounts, annunities can be considered. As a rule, in order for the tax-deferral advantage to outweigh the higher costs associated with variable annuities, an investment usually must remain in the annuity for at least 10 years.

There are fixed annuity and variable annuity.

With a fixed annuity, you invest an amount of money, and the insurance company makes a series of payments to you for a number of years or for your lifetime.

With a variable annuity, you choose how to invest the money; the amount you receive later depends on the investments you chose. This has the accumulation phase and the distribution phase. For accumulation, you can establish a qualified annuity by transfering money from a qualified retirement savings plan such as 401(k) or IRA. Such a transfer is tax-free. Or you can establish a non-qualified annuity by directly contributing money to the account. For distribution, federal tax law requires that you begin taking money out of a qualified annuity soon after you turn 70-1/2. For a non-qualified annuity, federal tax law has a limit on how much you can invest, and you do not have to begin withdrawals until you reach 85. The transfer from 401k and IRA accounts to an annuity is tax-free.

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