Millions of investors use IRAs to take advantage of tax-deferred growth for their retirement savings. At some point, though, retirement savers need to start taking money out of their IRAs to cover living expenses, and some prefer to look into annuities that will provide a predictable stream of cash to cover expenses. You can usually convert an IRA to an annuity without any immediate tax consequences, but there are implications when you start receiving payments. In addition, you have to make sure you handle the details correctly to avoid a big tax surprise.

Making the annuity move
Technically, the best way to start receiving annuity payments isn't to convert your IRA. Instead, you can take the money that's already inside your IRA and use it to buy an annuity. If your current IRA provider won't sell you an annuity, then you can do what's known as an IRA direct transfer to move the money into an IRA with a financial institution that will allow insurance product investments in a retirement account.

As long as you never take possession of the money, then there won't be any tax consequences. If you ask for a check from your current IRA provider, however, you'll have started the 60-day clock on what's known as a rollover process. Under this slightly different rule, you have to redeposit the full amount of your IRA with the new provider before the 60-day period expires. If you don't, the entire amount you moved will be included in your taxable income.

Handling annuity payments
Once you've invested in an annuity, you can set it up to start making payments to you at any time. As with all traditional IRA distributions, annuity payments will trigger taxes when you start receiving them. Because the annuity is held within an IRA, the full amount of the annuity payment will be included in your taxable income, and you'll have to pay ordinary income tax on the money.

Finally, keep in mind that penalties can apply both on the IRA side and with the annuity. Early withdrawal penalties of 10% apply to IRA or annuity withdrawals before age 59 1/2. However, the annuity provider can also charge withdrawal fees in certain circumstances. Be sure to look closely at your payout options to make sure you get a good deal.

Annuities can make a smart investment in an IRA, but you have to know how to handle them. Otherwise, some of the tax impacts can come as a shock.

This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at Thanks -- and Fool on!