IRA vs. Annuity: Which Is Better for Your Retirement Savings?

By Brandon Renfro

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You have a lot of options to choose from when deciding how to save for retirement. There are different account types, some of which are provided by your employer and some that you open on your own. There are also many different investments to pick from whether that is inside a retirement account or a taxable brokerage account.

Two common choices for retirement savings are IRAs and annuities. Learn what they are and the pros and cons of each.

Individual Retirement Account

An IRA provides you with specific tax advantages on your retirement savings. Money held in an IRA is invested, and those investments are shielded from taxes. That means that the dividends, interest, and capital gains that you earn in an IRA do not create a tax bill for you.

There are two basic types of IRAs: traditional and Roth. They have the same contribution limits, which are $6,000 for anyone under 50 or $7,000 for anyone 50 and over. The way contributions and withdrawals are taxed are treated differently. This tax difference is the main reason to choose one type over the other.

Traditional IRA

When you contribute money to a Traditional IRA you are able to deduct the value of your contribution from your current year’s income for tax purposes. You can then invest that contribution and let it grow inside the IRA, shielded from taxes until you retire and start to withdraw it. When money is withdrawn from a traditional IRA it is taxed at your marginal income tax rate.

Roth IRA

A Roth account basically reverses this tax treatment. You do not get to deduct Roth IRA contributions, but as long as you follow some basic rules such as not withdrawing before you reach 59½, your withdrawals are not subject to income taxation — including the growth on your contributions.

An IRA can be a good savings vehicle for most people. Whether or not you choose a traditional or Roth depends on how you’ll maximize your tax savings. If you’re in a higher tax bracket now than you expect to be in retirement, a traditional IRA makes more sense.

It’s important to recognize that an IRA is an account type. That means you’ll still need to choose investments within the account once you make your contribution.

You can open an IRA with a financial planner, at an online brokerage firm, and at most banks. The biggest factors to consider when thinking about where to open your IRA are whether you will want professional help with planning and investing, the associated fees, and investment options.

Pros and cons of IRAs

Pros Cons
Provide tax advantages on retirement savings. There are limits on how much you can contribute.
Allow for a wide variety of investment options allowing you to be as aggressive or conservative as you like. You will incur penalties for early withdrawals.
Offer flexibility as to when and how much you can withdraw in retirement. Traditional IRAs are subject to required minimum distributions once you reach 72.

Annuities

Unlike an IRA, annuities are not an account type. Annuities are insurance products that sometimes contain investment components.

There are many different types of annuities, but the general concept of an annuity is that you pay a premium or premiums in exchange for a guaranteed return or stream of income later.

There are no limits to how much you can save in an annuity like there are for an IRA. Like an IRA, the money you invest in an annuity grows tax-deferred. Once you start receiving money from your annuity you will be taxed.

Annuities can vary greatly from product to product, and it’s very important to read and understand the contract of any annuity product you consider buying. Regardless of specific differences between annuities from different issuers, there are some basic characteristics of different types.

Annuities can differ as to when you start receiving payments.

Immediate annuities

Immediate annuities begin paying an income stream as soon as you buy them. With this type of structure, you are paying for the benefit of the income stream.

Deferred annuities

Deferred annuities begin paying at a later date that you choose that will be reflected in your contract. You can either pay for a deferred annuity all at once or with regular premiums over time. These annuities are cheaper than comparable immediate annuities because the benefits start later.

Annuities can also differ in regards to how your payments are calculated.

Fixed payments

An annuity that offers a fixed payment will pay a steady amount regardless of what the market does or how interest rates move.

Variable

A variable annuity incorporates an investment component, and your annuity grows according to how your investments perform. Your contract may stipulate a certain minimum or maximum amount of return that your account can receive annually.

You’ll also need to decide the payout term. Some annuities will continue to pay for your entire life, or even for the life of your spouse if you pass away. Others may pay for a specified period of time such as 10 years.

Annuities are first and foremost insurance products. They are most beneficial to investors who want them for the guarantees they provide. In retirement, immediate annuities with a fixed payment can provide a foundation for covering minimum necessary expenses in retirement that aren’t tied to investment performance. Because they are insurance products, you must buy them from a licensed insurance agent.

Pros and Cons of annuities

Pros Cons
Annuities may be able to provide a fixed stream of income for a portion of your retirement savings. Contracts can be complicated and hard to understand.
Earnings can grow tax-deferred. Because it’s an insurance product, you are paying a premium for the guarantees on returns or payment amounts.
May offer a guaranteed payment for life. You give up control of the money you invest in an annuity and may face steep surrender penalties if you want to withdraw it.

IRA vs Annuity: How to Choose

An IRA offers the most flexibility and control over your investments and distribution options. However, an IRA is subject to contribution minimums.

Annuities offer less flexibility but can satisfy specific concerns such as uncertainty of investment performance.

Your choice should depend on which factors are more important to you, and how each would help you reach your retirement goals.

Frequently Asked Questions

What happens to my annuity when I die?

You can name a beneficiary to your annuity, who will receive it upon your death if there is a death benefit.

When can I withdraw from my annuity?

You can withdraw from an annuity once you reach 59½ without paying an early withdrawal tax penalty. Your contract my specific a later time that you can withdraw without incurring a penalty from the insurance company.

Can I contribute to my retirement plan at work and an IRA?

Yes, but depending on your income you may not be able to deduct your IRA contributions.

Can I deduct investment losses in my IRA?

No, investment losses inside your IRA cannot be deducted on your tax return or used to offset other investment gains.

About Author
Brandon Renfro
Brandon Renfro is a Certified Financial Planner (CFP), a Retirement Income Certified Professional (RICP), and an IRS credentialed Enrolled Agent (EA). He runs his own retirement and wealth management firm and is an assistant professor of finance. Brandon is a regular contributor to MoneyRates and several other financial publications. Brandon's wealth of expertise and practical knowledge have led to him being quoted in The Wall Street Journal, Forbes, U.S. News & World Report, AARP, Business Insider, and other national publications.