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Annuity vs. IRA: Which Is Best for My Retirement?

Nov 09, 2021 4 min read Rebecca Lake

Key takeaways

  • Annuities can provide guaranteed retirement income.
  • Both IRAs and annuities can offer tax-deferred growth.
  • Weigh the costs of investing in an annuity vs. an IRA.

 

When planning your retirement future, annuities and individual retirement accounts (IRAs) are two tools you might consider. An annuity is an insurance contract that’s designed to provide you with a consistent stream of income when you retire. With an IRA, you’re able to build a nest egg during your working years on a tax-advantaged basis.

Here we look at an annuity vs. an IRA. Read on to see which is better for retirement.

 

 

What are annuities, and how do they work?

When you purchase an annuity, you’re exchanging current assets for future income. You make a single lump-sum or a series of payments to the insurance company you’re buying the annuity from. The insurer then makes payments back to you, beginning at a specified date.

You can choose when payments begin, how long they last, and whether they should continue being made to your spouse when you pass away. In the meantime, the money you’ve invested in the annuity grows tax deferred. Payments are treated as taxable income once you begin making withdrawals.

There are three categories of annuities to choose from:

  • Fixed,

    which offer a predictable rate of return

  • Variable,

    which offer a return based on investment performance

  • Indexed,

    which blend characteristics of fixed and variable annuities

The main objective of an annuity is to provide you with a reliable source of income in retirement. Having a steady “paycheck” you can count on in your later years could give you some reassurance if you’re concerned about spending down your other retirement assets too quickly, or you’re worried that your Social Security benefits won’t be enough to cover any gaps in your monthly income.

 

What is an IRA?

IRAs take a different approach to retirement saving. These accounts are offered by brokerage firms. Instead of paying premiums, you contribute money to your IRA directly, up to the annual contribution limit. For 2022, the limit is $6,000 ($7,000 if you’ll be 50 or older by year-end).

Contributions to “traditional” IRAs are tax-deductible; with Roth IRAs you contribute after-tax dollars. Either way, your money grows tax deferred and can be invested in mutual funds, exchange-traded funds (ETFs) or any other investment your brokerage firm offers. Beginning at age 59½, you can typically withdraw from your IRA without triggering a 10% early-withdrawal penalty.

Whether you owe taxes on withdrawals at age 59½ or later depends on the type of IRA:

  • Traditional IRA

    withdrawals (including ones made from SEP and SIMPLE IRAs if you’re self-employed) are taxable at your ordinary income tax rate.

  • Roth IRA

    qualified withdrawals are 100% tax free.

Note that required minimum distributions (RMDs) kick in after age 72 (unless you reached 70½ in 2019): You must start taking money from your traditional IRA each year. The amount is based on your account balance and life expectancy. (Roth IRAs don’t have that requirement.)

 

What's the difference between an annuity and an IRA?

Annuities provide guaranteed retirement income. You make a lump-sum payment or multiple payments. In exchange, you get money to live on in retirement. IRAs require you to make contributions and decide how to invest that money and when to take distributions. An IRA’s return on investment may vary depending on the market and how you choose to invest the money, but it does give you more flexibility.

 

Can I roll an annuity into an IRA?

If you start out with a variable annuity and later decide you’d prefer to put that money into an IRA, you may be able to roll it over. If the account was set up with pre-tax dollars, you may be able to roll it into a traditional IRA. If it was set up with after-tax dollars, you may be able to roll it into a Roth IRA.

 

Annuity vs. IRA: Which should you use for retirement?

An annuity may be appropriate if you want guaranteed income. With an IRA, it’s up to you to decide when to make withdrawals. It’s also worth noting that if you’re saving in a traditional IRA and forget to take required minimum distributions, you can be hit with a tax penalty.

Ultimately, whether to choose an annuity or IRA depends largely on your retirement goals. If you want the certainty of guaranteed income, an annuity can deliver. An IRA might be preferable if you’re looking for more flexibility in choosing investments.

 

What you can do next

If you think an IRA may be the better option, weigh the pros and cons of traditional vs. Roth IRAs, and consider whether you’re income-eligible to contribute to a Roth. If you’d like to invest in an annuity, learn more about fixed, variable and indexed annuity options.

Please consult your tax and legal advisors regarding your particular circumstances.

Footnotes

  • Annuity contracts contain exclusions, limitations, reductions of benefits and terms for keeping them in force. Your licensed financial professional can provide you with complete details.
  • Prudential Financial, its affiliates and their financial professionals do not render tax or legal advice. Please consult with your tax and legal advisors regarding your personal circumstances.

 

Rebecca Lake has covered finance, investing and small business for more than a decade. Her work has appeared online at U.S. News & World Report, MSN Money, Business Insider and Investopedia, among others.

 

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