What is the primary purpose of an annuity purchased with after-tax money?

An annuity purchased with after-tax money primarily serves the function of generating both a return of principal and income that will be subject to taxation. When you buy an annuity with after-tax funds, the contributions you made to the annuity have already been taxed. Consequently, when you start receiving payouts from the annuity, a portion of these payouts will be considered a return of that original principal (which is not taxed) while the remainder, reflecting earnings on the investment, will be taxable as ordinary income.

This structure allows annuities to provide a steady income stream during retirement, blending both your initial investment and the income generated from it. Essentially, while the principal is not taxed upon withdrawal, any growth that has occurred in the annuity’s value does incur tax liabilities when distributed. This differentiates annuities from other tax-advantaged accounts which may provide tax-deferral advantages for contributions and earnings.

In contrast, other options mainly focus on avoiding taxes or accumulating savings without addressing the nature of the payouts accurately, missing the nuance that part of the income from this specific type of annuity is indeed taxable. Understanding this is vital for evaluating how annuities fit into a broader retirement strategy regarding taxation and income planning.