Q. Can you explain what it means to purchase an annuity "inside" of an IRA?

A. If you purchase an annuity inside of an IRA or other qualified plan, your purchase is made with the same money that you invest in the IRA. You simply direct its investment into an annuity. Annuities can play an important part in your retirement planning, but they may also involve a lot of options, possible penalties for early withdrawals, or other fine print. Be sure to check with your financial advisor very carefully before investing.

The taxation of annuity money inside of IRAs is treated like any other investment inside of an IRA. The basic rules regarding investment in IRAs are covered in questions from previous newsletters. For review, please see July 2001 and June 2001. However, there may be additional withdrawal and/or liquidity issues with each separate annuity contract. Make sure you understand these terms from the annuity company before you invest.

Most annuities within an IRA are variable annuities (an equity- indexed annuity is another option, but you should meet with your financial advisor to weigh the pros and cons very carefully). Variable annuities are still life insurance products, but they are separate from the company's assets and are managed by an independent, mutual fund manager. This means that you can retrieve your money more easily if the company fails. Also, variable annuities offer some interesting riders. For example, they might guarantee your investment, plus 5 to 10% per year. A death benefit option can provide your beneficiaries with the highest value of your annuity over time, even if that value is lower at the time of death. The availability of different riders varies between companies.

If you are interested in annuities, you should locate an advisor who is properly licensed to sell annuities. This means that the advisor has both a life insurance license and a series 63 license. He or she should be able to offer you a variety of annuity products from different companies. In addition, it is preferable to work with an advisor who can show you a broad variety of investment strategies, which includes annuities, mutual funds, CDs, stocks, etc.