Definition of a Retirement Annuity

A retirement annuity is an investment product or account structure that gives the account holder tax-deferred growth on money. The money is designed to supplement federal retirement income, helping the annuity owner have the means to live a comfortable lifestyle in retirement comparable to his life before retiring.


The term retirement annuity does not refer to one specific account. It most commonly is associated with a tax-sheltered annuity, also known as a 403b retirement plan. These annuities are employer-sponsored retirement plans where all contributions are pre-tax dollars. An investor may also open a qualified annuity at an insurance company, contributing up to $5,000 annually into either a traditional or Roth IRA. There are also nonqualified annuities where investors have no contribution limits; the annuities are offered by insurance companies and use after-tax money where earnings defer taxes until distributed.

Defining Retirement

Most retirement annuities use the age of 59 1/2 to define the start of retirement and thus the ability for an investor to pull assets out of the retirement annuity without tax penalty. However, tax-sheltered annuities such as the 403b plan have a special retirement clause based on employment history. Employees who remain with the company until at least age 50 may access the 403b starting at age 55 without penalty as long as the annuity remains with the employer plan. Rolling it over into a self-directed IRA disqualifies investors from this early retirement option.


It is important to understand that annuities are tax-favored, not tax-exempt. All annuities grow tax-deferred with one exception, a Roth IRA annuity that grows tax-free. Any money taken out of deferred annuities is added to the investor's adjusted gross income for the year of the distribution. For nonqualfied annuities where the contributions were after-tax money, only the earnings are added to income. The IRS considers all distributions earnings until 100 percent of all earnings is removed from the annuity.

Exceptions for Distributions

Distributions made before age 59 1/2 are subject to a 10 percent IRS tax penalty regardless of whether the retirement annuity is qualified or not. However, qualified annuities (tax-sheltered annuities and IRA annuities) have exceptions that allow investors access to qualified assets without penalty. One exception is using the funds for college tuition, whether for self or a lineal family member. Another exemption is taking $10,000 out to buy or build a home. There are also hardship distribution rules that allow access to annuity money to prevent foreclosure or pay medical expenses.


Retirement annuities held through employer-sponsored plans may have a loan privilege. The IRS does not allow loans on IRA annuities or nonqualified annuities, but certain employer plans may opt to allow loans up to the IRS limitations. The IRS allows tax-sheltered annuity plans to offer participants a loan of 50 percent of the annuity value up to $50,000. The loan must be repaid while the employee is working for the organization and within five years.


About the Author

With more than 15 years of professional writing experience, Kimberlee finds it fun to take technical mumbo-jumbo and make it fun! Her first career was in financial services and insurance.