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OK, so even if we don't reach the AGI contribution limits I still can't convert them because there is a lower conversion AGI limit. Basically this money is now trapped in an annuity, the only option I have is to transfer it into another annuity w/ a different company.

No. It is trapped in a traditional IRA. If you're willing to suffer the surrender fees, you can move the money from an IRA annuity to a traditional IRA at another financial institution such as a bank or brokerage.

My original plan was to transfer the cash into a Vanguard IRA, so I looked at Vanguard's annuities. They seem to have some similar fund options so maybe this won't be too bad?

That could be one option. You'll still have to consider the surrender charges with the existing annuity.

Can anyone give me a layman's explanation on the difference between an annuity and Roth? For whatever reason I find IRA's the most confusing part of investing.

I'll try.

First off anniuties and Roth IRAs are like comparing apples and hand grenades.

An annuity is a type of investment. In the old days, annuities were simple things. You gave an insurance company a pile of money in exchange for a monthly payment for your lifetime. Essentially, you were betting that you would live longer than average and the insurance company was betting that you wouldn't. This is called an immediate annuity. The monthly payments start right after you buy the annuity.

An annuity is, in a way, the opposite of life insurance. With life insurance, you give the insurance company a monthly (or annual) payment in exchange for a pile of money when you die. There, you are betting that you live less than an average time, and the insurance company is betting that you live longer than average.

(In reality, the insurance company sort of "rigs" the game. They skew the average lifetime in their favor in either situation. With an annuity, they use an average lifetime that is longer than statistics would predict. And for life insurance, they use a lifetime shorter than the statistical average.)

After that original kind of annuity came a wrinkle on the annuity. Instead of getting your payments right away, the first payment was deferred for a while. By deferring the start of the payments, you would get a higher monthly payment since the insurance company would be investing the money for some time until the payments started.

Then came the ability to add money to your deferred annuity from time to time. You'd make the first payment and be guaranteed a certain monthly payment. Then, as you decide to increase that future payment, instead of buying another annuity you could just add money to your existing annuity.

Then some people decided the wanted protection in case they died really early. Remember that the monthly payments stop when you stop. So the insurance company offered a "term certain" where they'd make payments after your death to a beneficiary if you hadn't collected enough from the annuity. This keeps you from losing a whole lot of money if you die well before the statistics say you should.

Then instead of getting a monthly payment in the future, they allowed you to just take out any amount you'd like - as long as it didn't exceed some calculated figure. The insurance company would periodically calculate a value for the annuity and let you take out any amount up to that value. If you don't take money out, the value continues to increase. Once you take money out, the value drops by the withdrawal, then continues increasing from there with the investment returns.

Then, instead of the insurance company deciding how to invest the money, they let YOU decide how to invest the money. So you get to pick some mutual fund type of investments - like a market average fund or an international fund or a small cap fund or whatever. Now that changing value is more in your hands and less in the hands of the insurance company.

That, in an overly-simplified nutshell, is annuities.

An IRA is more like an account. You might have a CD or a money market account or a brokerage account. Any of these accounts could be designated as an IRA account. If you wanted to invest your IRA money in a CD, you'd contact your bank and open an IRA account there. Or if you wanted to invest your IRA money in a mutual fund, you'd open an IRA account with a mutual fund company. If you wanted to invest your IRA money in stocks and bonds, you'd open an IRA account with a stock broker. And if you wanted to invest your IRA money in an annuity, you'd open an IRA account with an insurance company.

To complicate things just a bit, IRAs come in two flavors: Traditional and Roth. Traditional IRAs have been around since the 1970s, although they really didn't gain popularity until the mid 1980s. Roth IRAs were created in 1997. They are similar in the way they operate. The only difference is in how they are taxed.

Traditional IRA contributions can be tax-deductible. You can deduct the contribution from your taxes and defer that tax until you withdraw the money - typically in retirement when your tax bracket is lower. Roth IRA contributions are not tax-deductible. Making a contribution to a Roth IRA does not reduce your current taxes. But the trade off is that future withdrawals from the IRA will be tax-free - providing you meet certain criteria (mainly that the account be open at least 5 years and that you are over 59 1/2.)

Hopefully some of this helps clear away the confusion you have.

--Peter
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