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How an Individual Retirement Annuity Works


An individual retirement annuity can provide guaranteed lifetime income, making it a potentially useful tool in retirement planning. It also comes with tax perks, similar to other retirement planning tools such as an Individual Retirement Account (IRA). However, individual retirement annuities differ from IRAs in key ways, including investing costs and flexibility in selecting investments. Before buying an individual retirement annuity, consult a financial advisor to see if it fits your goals.

Defining an Individual Retirement Annuity

An individual retirement annuity is an annuity held within a tax-advantaged account similar to an IRA. With an individual retirement annuity, however, you make premium payments to the insurance company rather than contributing deferred salary to an IRA. Later when you retire, rather than taking funds from your IRA to get money to pay expenses, you get regular guaranteed payouts from the insurance company.

Another important difference versus a traditional IRA is that an individual retirement annuity can only hold annuity contracts rather than general investments. You purchase an annuity contract from an insurance company.

To buy the annuity, you pay either a lump sum upfront or make periodic premium payments to the insurance company. In return, the insurer provides reliable income payments, either immediately or starting later. The money in your annuity grows tax-deferred until you take withdrawals.

There are two primary types of annuities. Immediate annuities provide income right after purchase when you give the insurer a lump sum. Deferred annuities begin making payments years later, allowing time for your account to grow through periodic contributions.

Using Annuities in Retirement Planning

The main reason to use an annuity is to guarantee lifetime income that lasts your entire retirement. Having guaranteed lifetime income helps hedge against longevity risk or the chance that you will outlive your money.

Typically, monthly payments from the annuity get used to supplement regular income from other sources such as Social Security or pension benefits. Annuities provide peace of mind because they can be used to minimize the risk of outliving your income stream.

Other potential benefits include:

  • Spousal benefits so a surviving spouse keeps getting income
  • Customizable features for an added cost

How Individual Retirement Annuities and IRAs Differ

SmartAsset: How an Individual Retirement Annuity Works

Both IRAs and individual retirement annuities offer tax advantages for retirement savings. However, there are some notable differences:

  • Individual retirement annuities can only hold annuity contracts, while IRAs can hold diverse investments such as stocks, bonds and mutual funds.
  • Annuities guarantee lifetime income, while IRAs do not come with a guarantee.
  • IRAs typically have lower fees and more flexibility than annuities.
  • IRAs offer higher potential returns through stock market investing.
  • Annuities restrict access to funds through withdrawal limits and penalties.

Pros and Cons of an Individual Retirement Annuity

Below are some key upsides and downsides of using an individual retirement annuity:


  • Guaranteed income for life 
  • Income can cover fixed retirement expenses
  • Tax-deferred growth potential
  • Lower risk than investing in the stock market    
  • Death benefits for beneficiaries


  • Limited liquidity and access to funds
  • Potential for lower returns than self-investing
  • Annuity income payments are taxable
  • Income stops at annuitant’s death

To summarize, individual retirement annuities provide income security with tradeoffs around liquidity, growth and costs.

An Individual Retirement Annuity Example

A 65-year-old recently retired man with $300,000 in his IRA and $2,500 per month from Social Security wants more guaranteed income without giving up all prospects for additional growth. He uses $150,000 of the funds in his IRA to purchase an immediate annuity that pays 6% or $9,000 annually. This provides him with an additional $750 per month of lifetime income.

The remaining $150,000 in his IRA stays invested in mutual funds for growth. By 70, Ken can start tapping these funds for discretionary spending. Meanwhile, his Social Security benefits, which are indexed to inflation, plus the annuity income will likely cover his basic costs no matter how long he lives.

How to Buy an Individual Retirement Annuity

If an individual retirement annuity is right for you, here are five common tips to buy one:

  • Consider your target for guaranteed retirement income needs
  • Choose between immediate or deferred annuities
  • Review all fees, terms and limitations before signing the contract
  • Fund the annuity from existing IRA savings or rollover accounts

Assessing the costs, benefits and features of the many annuity types can be complex. Work with a financial advisor for guidance on selecting an annuity.

Bottom Line

SmartAsset: How an Individual Retirement Annuity Works

For some retirees, an individual retirement annuity can provide stable, guaranteed lifetime income. However, individual retirement annuities limit liquidity and upside investment potential. Before purchasing one, discuss the tradeoffs with your financial advisor to see if it fits your overall retirement plan.

Tips for Retirement Planning

  • Consider discussing annuities with a financial advisor to see if one fits your retirement strategy. 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.
  • You can’t plan wisely for retirement unless you have a fix on your Social Security benefits. Use SmartAsset’s Social Security Calculator to get answers.

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