Understanding 408(b) Annuities: Retirement Savings Explained

Annuities are insurance policies. These contracts may do one of two things. They may provide you with a guaranteed income for life or for a set number of years. Otherwise, they may function as a long-term savings. A 408(b) annuity is an annuity that is housed inside of an Individual Retirement Account.

Purpose

The purpose of a 408(b) plan is to build up a savings for your retirement. The annuity policy is purchased inside of an Individual Retirement Plan (IRA). The annuity functions similar to annuities outside of the IRA, though the annuity is subject to all of the regulations pertaining to IRAs.

Benefit

The benefit of the 408(b) annuity is that the annuity offers the option for a guaranteed retirement income. Fixed annuities guarantee a retirement savings amount in the future, while variable annuities give you the opportunity to have a retirement savings that is higher than the guaranteed annuity amount. Additionally, all contributions to the plan are made on a tax-deductible basis.

Disadvantage

The 408(b) annuity is limited by the contribution limits placed on the IRA. Normally, there are no contribution limits on an annuity. The contribution limits are $5,000 per year for the 408(b) plan (as of 2011). This restricts your ability to save money. Additionally, withdrawals from the plan are fully taxable. With a traditional annuity, only the investment gains are taxable because all contributions are after-tax with a traditional annuity.

Consideration

A 408(b) plan may be beneficial for you if you want the advantage of tax-deductible contributions. But, your tax rate in the future needs to be the same or lower than your current rate. Otherwise, the benefits of the 408(b) plan evaporate since you'll pay more in tax than you saved by using the plan.