Annuity vs. IRA for Retirement

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When preparing for retirement, you’re faced with financial choices. One is whether to open an individual retirement account (IRA) or purchase an annuity. Although both are sound retirement mechanisms, they are different in how they work and are financed.

But how do they work, and do they both have tax advantages? It’s essential to have the facts about annuities and IRAs to make an informed decision.

How Does an Annuity Work?

An annuity is an insurance product, and it is a long-term contract. You invest your money in this product and, in return, you receive regular payment through annuitization. Annuitization is a guaranteed lifetime income benefit.

When purchasing an annuity, you make a lump-sum payment or a series of installments to an insurance company or financial institution. During this phase, your annuity can grow on a tax-deferred basis. The company invests your money, and the annuity’s growth depends on these underlying investments.

Regular payments are made to you once you’ve entered the distribution phase. The payment schedule depends on what type of contract you purchased. They can be 10–20 years or a lifetime.

How Does an IRA Work?

Think of an IRA as a savings vehicle. It’s a pot filled with your money, and it grows. An IRA is an account that is set up at a financial institution. It allows you to save for retirement with tax-free growth or a tax-deferred basis.

You can contribute to an IRA and 401(k) simultaneously.

Differences Between Annuity and IRA

Although an annuity and IRA are savings vehicles for retirement, they are different.

An annuity provides you with a steady stream of income during retirement. And depending on what type you choose, this income could last a fixed period or your entire life.

IRAs are tax-advantaged accounts. They allow you to save and invest for a larger nest egg during retirement.

But both IRAs and annuities have the potential to offer tax advantages to an individual.

If you contributed to an annuity in after-tax dollars, you'll only owe taxes on the account’s earnings when you start receiving payments.

A traditional IRA allows for tax-deferred growth until withdrawals begin. These can start at 59½. But another IRA, called a Roth IRA, gives you the benefit of tax-free growth and tax-free withdrawals.

Can an IRA Roll Over to an Annuity?

You can roll over an IRA into an annuity. And if it’s handled in an IRS-compliant way, you won’t incur any taxes or penalties.

There are some benefits to rolling over the IRA.

You’ll be able to achieve a lifelong income stream. This eliminates the risk of holding assets that exhibit volatility. An annuity is safer.

You also won’t have to worry about outliving your savings since you can choose an annuity that pays for life.

Pros and Cons of an Annuity

Achieving a steady income stream is attractive. And although you can use an IRA to generate income, you are incurring risk.

You can choose between an immediate or a deferred annuity. Since annuities convert existing savings into guaranteed payments, you don’t have to worry about outliving your funds.

The required minimum distribution (RMD) rule doesn’t apply to annuities. The RMD is the minimum amount you must withdraw yearly beginning at the age of 72–72½ from a retirement account. This means with an annuity, you can defer payments until age 85. It helps you avoid going up into a higher tax bracket. It could also lower your Medicare premiums.

But there are some cons.

Annuities are complex. They have terms and conditions that can be confusing. And since insurance agents earn a commission from your money, you may fall prey to an unethical salesperson.

There’s a guaranteed income, but returns are much smaller than with many IRAs.

Liquidity is an issue with an annuity. Once you start withdrawing, your monthly distributions are fixed per the terms of your contract.

You also have high fees. This makes annuities more costly than other retirement vehicles like an IRA. Some fees include:

• mortality and expense risk charges
• administrative fees
• fund management fees

Altogether, this could add up to 3–4 percent yearly.

Check with an independent financial advisor who does not sell annuities to explore if this is the best vehicle for you.

Pros and Cons of an IRA

An IRA is portable. You can transfer from one to another with ease.

Another pro is the tax benefits under certain circumstances. A traditional IRA account holder receives a tax deduction when making IRA contributions. Then, their distributions are taxed at ordinary rates. With a Roth IRA, you pay taxes on contributions up front, but distributions in retirement are not taxed.

The funds contributed to an IRA can be invested into almost any type of financial product. This includes:

• real estate
• gold bars
• mutual funds
• etc.

This gives you control over your account.

But a downside is the limitation on contributions per year. In 2023, the maximum contribution to an IRA is $6,500. If you’re over 50, it’s $7,500.

There are also early withdrawal penalties if you withdraw from an IRA before you reach 59.

Is an Annuity or IRA Better?

Annuities and IRAs can both aid you in reaching retirement goals. But which one you choose depends on your circumstances.

If you are near retirement age, an IRA may not make sense. That’s because it’s a long-term savings vehicle. It won’t have enough time to grow. An annuity can be purchased when you’re near retirement age.

But an IRA may be the right choice if you’re far from retiring. Once you’ve contributed the maximum to your annuity, you may want to add an annuity.

Talk to a financial adviser and see what direction makes sense for you.

The Epoch Times copyright © 2023. The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.