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Annuity vs. IRA


Americans look forward to their golden years, but saving for retirement can be an intimidating undertaking. The long-term nature of this type of financial planning calls for good decision-making, so simplifying it is of the utmost importance. Let’s break down two of the most common retirement investment vehicles: annuities and IRAs. If you need help finding the right types of investments, or accounts, for you then you may want to talk to a financial advisor.

What Is an Annuity?

An annuity is a retirement savings vehicle that provides a few advantages to account holders. Principal among these benefits is the ability to save on a tax-deferred basis. This means that you will not have to pay any income taxes on the investment returns and/or interest rate of your annuity until you begin taking from your balance in retirement.

While tax-deferred growth is not unique to annuities, it is a major strength: It allows you to save more, as your balance remains in a constant state of growth. Should you begin taking money from your account early, the penalties are steep. Most annuities come with withdrawal charges of up to 10% for the first several years of ownership. Furthermore, anyone under 59.5 years old will receive a 10% surtax, courtesy of the IRS.

There are many different styles of annuities, but you can boil them down to three distinct groups: variable annuities, fixed annuities and indexed annuities. Fixed annuities offer the most reliable returns, as all earnings are based on pre-decided interest rate terms. If you can afford to take on some investment risk, variable annuities let you invest your money in the market.

Indexed annuities fall somewhere in between their fixed and variable counterparts. When you open one, you’ll select a market index that your account’s funds will track the performance of. Normal options include the S&P 500, Russell 2000® and MSCI EAFE.

The fees associated with annuities vary from company to company. Some have annual fees and other maintenance charges, but many surprisingly don’t. So where do annuity companies make their money? Optional benefit riders are extra perks that prospective annuitants can annex onto their account for what typically amounts to a 0.5% to 2% annual charge. Some examples of these benefit riders are death benefits to ensure beneficiary payouts and income riders that offer a boost to your returns.

What Is an IRA?

Annuity vs. IRA

An individual retirement account, or IRA, is one of the most common retirement savings accounts today. At their core, IRAs are a medium through which account holders can invest their retirement savings or apply them to a fixed interest rate. Similar to annuities, there are multiple variations of IRAs, such as traditional IRAs, Roth IRAs and rollover IRAs.

The most basic account within this trio is the traditional IRA. Instead of deferring your taxes, contributions up to $6,500 ($7,500 for anyone 50 and older, which increases to $7,500 and $8,500 in 2024) are tax-deductible, though you’ll need to pay income taxes when you begin withdrawing.

Roth IRAs work oppositely: Roth account holders cannot deduct their IRA contributions, but they won’t have to pay income taxes on them in retirement. For those with a 401(k) through their job, a rollover IRA will let you transfer the funds from your old account to a new IRA.

Annuity vs. IRA: Which Is Better?

When comparing annuities and IRAs, there’s rarely a definitively “better” choice. Alternatively, there are simply people who are better suited for certain products over others. Take a look through these initial considerations to figure out where you stand:

Annuity vs. IRA

AccountBenefitsDrawbacksBest For
Annuity– No annual contribution limits
– Great as a supplemental fund
– Early withdrawal charges can be hefty when combined with IRS penalties
– Possible sales commissions
– Those nearing retirement with beneficiaries
– Anyone who wants fixed payments in retirement
IRA– Personalized tax benefits
– Can be aligned with professional money management
– No built-in payout control– Self-sufficient investors
– Individuals far from retirement age

If you’re planning to retire in the next decade or so and want to supplement your existing retirement funds, annuities can be conducive to that initiative. The promise of regular monthly payments can be very comforting, especially when paired with beneficiary, death and income benefit riders.

On the other hand, an IRA can serve as a major retirement strategy to save for the future throughout your career. They offer the most flexibility, have strong tax advantages and can easily integrate with a personal investment portfolio. In other words, start your savings with an IRA, and if you have any leftover funds, place them in an annuity.

How to Open an Annuity and an IRA

Annuity vs. IRA

Because annuities are insurance products, you must buy them through an insurance company. You can also purchase annuities via middlemen as well. This includes financial advisors, brokers, independent insurance agents, banks, brokerage firms, broker-dealers and mutual funds.

Brokerage firms almost always offer an IRA account variation. This gives you the most control over the investment of your money. But if you go this route, be sure that you feel comfortable navigating the investment market on your own. Some brokerages do offer the help of financial advisors, or you can find your own advisor.

Robo-advisors are perfectly viable options for anyone who prefers a more automated IRA investment approach. Upon joining a robo-advisor, you will select your personal risk tolerance and a number of other investment factors. Once an adequate profile is built, your funds will be invested in the market according to a pre-specified asset allocation.

Similar to how certificates of deposit (CDs) work, banks provide IRAs with fixed interest rate tiers. Financial institutions usually divvy these up by term length, meaning the longer the term, the better the rate you’re given. Although brokerage and robo-advisor IRAs usually outperform this setup, the promise of an exact interest rate over a certain period is more than enough for some investors.

Tips for Your Retirement Savings

  • Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • SmartAsset’s retirement calculator can help you figure out if you’re on track for retirement.

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