The Difference Between an IRA and an Annuity

Employer-provided 401(k) and 403(b) plans have options for investing in mutual funds of stocks and bonds, real estate investment trusts, and money market funds. Some may also offer options to save in individual retirement accounts (IRAs) and annuities. Self-employed people also have options for establishing IRAs and annuities.

These products offer tax advantages by allowing savers to make contributions on a pre-tax basis, lowering taxable income during the years they’re accumulating savings and growing investments through interest, dividends, and capital gains. With pre-tax contributions, money is only taxed when the retiree withdraws it. When you’re choosing how to allocate contributions in retirement plans, it’s important to understand the difference between IRAs and annuities.

The main difference between an IRA and an annuity is that an IRA is a type of account that can hold a variety of investments, whereas an annuity is an insurance contract paid for over time with regular tax-deferred contributions or purchased in a lump sum with after-tax dollars. An annuity can be one of the assets within an IRA account, but it can also be a separate asset.

In an IRA, the account owner can choose their own investments, and the value of those investments can fluctuate over time. With a fixed annuity, the insurance company manages the investments. Fixed annuities pay a guaranteed minimum payment over a set time, which could be the rest of the retiree’s life or the rest of a surviving spouse’s life.

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In a variable annuity, the purchaser has more say over how their money is invested, and the payout can fluctuate based on performance. Some variable annuities establish a minimum guaranteed payout despite market ups and downs. Indexed annuities track a stock index, and their value can also fluctuate. More flexibility in investments means the possibility of greater returns, but it requires acceptance of greater downside risk.

Annuities can carry high commissions and fees, especially if the owner takes early withdrawals. Surrender fees can be as high as 20% early in the life of the annuity contract.

IRAs have annual contribution limits set by the Internal Revenue Service. Annuities do not. However, annuity payouts are less flexible. With an IRA, the retiree can decide how much to withdraw and when, taking larger withdrawals in emergencies and leaving money to grow when they don’t need it. An annuity ties up a lot of money, and withdrawals are fixed and inflexible. Some retirees prefer the security of knowing they’ll get a check every month, quarter, or year, regardless of how the stock market behaves.

Both IRAs and annuities can be elements of a comprehensive retirement plan. Ask your financial advisor “What is a retirement annuity?” when you’re discussing retirement options. Your financial and tax advisors should help you determine how to manage annuities and other financial and tangible assets for a secure retirement.

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