Annuity vs IRA: what is the best solution for my retirement?

As you plan how to save for retirement, you’ll hear about IRAs and annuities. Both can generate income later in life, have potential tax benefits, and include penalties for early withdrawals.

But beyond these similarities, there are differences that can make one better than the other for your situation.

What are Annuities and IRAs? How are they different?

IRA is the abbreviation for individual retirement account, an account that you can use to buy stocks, bonds, mutual funds, and other assets to build up a retirement nest egg. There are two main types of IRAs, Traditional and Roth.

Traditional IRA: You contribute in pre-tax dollars – the contribution limit is $ 6,000 in 2021 ($ 7,000 if you are 50 or older). When you withdraw money in retirement, it will be taxed at your rate then, which may be lower. You will be subject to penalties for any withdrawals before age 59 and a half, and you must start making the minimum required withdrawals each year at age 72.

Roth IRA: The annual contribution limits are the same, but you invest in after-tax dollars, so withdrawals at retirement are not taxed. He is also more lenient with regard to early withdrawals and there are no minimum distributions required from age 72.

An annuity is an investment integrated into an insurance policy. You pay a premium, either all at once or over time. The insurer invests this money and in return pays you a guaranteed monthly, quarterly or annual payment starting at a specific point in time and extending over a number of years or for the rest of your life. There is often a 10% penalty for withdrawing before the age of 59.5.

Is An IRA A Good Choice For Your Retirement?

Along with employer-sponsored plans like a 401 (k), IRAs are the workhorses of modern retirement savings. For most people, an IRA is the next obvious choice once they have contributed at least enough to their 401 (k) to get the corresponding dollars from their employer.

  • You are in control of investment decisions and keep any gains when your investments are doing well.

  • You can pass an IRA to a beneficiary, such as your spouse or children.

  • The fees on IRAs are lower and easier to understand than annuity fees.

  • You can choose the IRA which will help your particular tax situation.

  • There is no guarantee that your investments will be profitable or how much they will earn you in retirement.

  • You have to be careful with the tax rules about how much you can invest, if you can deduct it, and when to withdraw money.

  • You could run out of money in retirement if you don’t save enough.


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Is an annuity a good choice for your retirement?

Guaranteed payments are great if you have to pay a big fixed expense like a mortgage in retirement or if you are worried about running out of money in old age.

  • You get a fixed payment you can count on.

  • You can choose an annuity that pays until you die, or until you and your spouse are both dead.

  • You can choose an annuity with a death benefit, which allows you to designate beneficiaries to receive unpaid funds.

  • Certain types of annuities can help high income investors seeking tax deferral who have already maximized their contributions to their 401 (k) and IRA accounts.

  • Inflation will erode the purchasing power of a fixed payment amount over time.

  • You have little (or no) say in annuity investments.

  • You get a fixed return and the insurer keeps the difference if the investments are doing well, although some types of annuities have payouts that fluctuate based on the return on the investments. Learn more about it below.

  • The fees are higher than the IRA fees and there is a potential “surrender” charge if you cancel your policy.

But perhaps the biggest downside to annuities is their complexity.

What to know before buying an annuity

Annuities can come in a wide variety of models, with varying payment terms, amounts and durations. These layers of complexity can make them difficult to understand.

Here are some types of annuities:

Fixed annuity: You pay a premium and then after a certain time you receive payments for a fixed amount.

Variable annuity: Allows you to choose certain investment options for your premium, such as mutual funds and bond funds. Sometimes minimum loss or growth rates are set.

Equity indexed annuity: to some extent track a stock index like the S&P 500 and guarantee minimum interest payments.

Annuities are said to be “more sold than bought” meaning that brokers may be keen to sell annuities because they have high commissions, rather than because they are a perfect fit for the client. .

This is true for all investment choices, but especially for complex products like annuities:

  • Ask lots of questions and make sure you understand all the details before continuing.

  • Shop around, as guaranteed payment quotes may vary by vendor.

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