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Annuity vs. IRA: Which is Best for My Retirement?

Annuity-vs-IRA


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This article originally appeared in the financial education center on Prudential.com. For more than 140 years, Prudential Financial has helped individual and institutional customers grow and protect their wealth. Prudential is known for delivering on its promises to its customers, and is recognized as a trusted brand and one of the world’s most admired companies* .

Key Takeaways

  • Annuities can provide guaranteed retirement income.
  • Both IRAs and annuities can offer tax-deferred growth.
  • Weigh the costs of investing in an annuity vs IRA.

When planning your retirement future, annuities and individual retirement accounts are two tools you might consider. An annuity is an insurance contract that’s designed to provide you with a consistent stream of income when you retire. Whereas with an IRA, you’re able to build a nest egg during your working years on a tax-advantaged basis. But what’s better for retirement, an annuity vs. IRA?

What Are Annuities and How Do They Work?

When you purchase an annuity, you’re exchanging current assets for future income. You make each lump-sum payment or a series of payments to the insurance company you’re purchasing the annuity from. The insurer then makes payments back to you, beginning at a specified date.

You can choose when payments begin, how long they last and whether payments should continue being made to your spouse when you pass away. In the meantime, the money you’ve invested in the annuity grows tax-deferred. Payments are treated as taxable income once you begin making withdrawals.

There are three categories of annuities to choose from:

  • Fixed annuities, which offer a predictable rate of return
  • Variable annuities, which offer a return based on investment performance
  • Indexed annuities, which blend characteristics of fixed and variable annuities

The primary objective of an annuity is to provide you with a reliable source of income in retirement. Having a steady “paycheck” you can count in your later years could give you some reassurance if you’re concerned about spending down your other retirement assets too quickly or you’re worried that your Social Security benefits may be insufficient to cover any gaps in your monthly income.

What is an IRA (Individual Retirement Account)?

An IRA takes a different approach to retirement saving. These accounts are offered by brokerage firms. Instead of paying premiums, you contribute money to your IRA directly, up to the annual contribution limit allowed each year. For 2020, the limit is $6,000, increasing to $7,000 if you’re 50 or older.

Contributions grow on a tax-advantaged basis and can be invested in mutual funds, exchange-traded funds or any other investment your brokerage firm offers. Beginning at age 59 1/2, you can withdraw from your IRA without triggering a 10% early withdrawal tax penalty.

Whether you pay taxes on qualified withdrawals at age 59 1/2 or later depends on the type of IRA:

  • Traditional IRA withdrawals (including ones made from SEP and SIMPLE IRAs if you’re self-employed) are taxable at your ordinary income tax rate.
  • Roth IRA withdrawals are 100% tax-free.

Note, required minimum distributions (RMDs) kick in after age 72 (unless you’ve reached 70 ½ in 2019), you’re required to start taking money from your traditional IRA each year. The amount is based on your account balance and life expectancy. Roth IRAs don’t have that requirement.

Annuity vs. IRA: What Should You Use for Retirement?

An annuity may be appropriate if you want guaranteed income. With an IRA, it’s up to you to decide when to make withdrawals. It’s also worth noting that if you’re saving in an IRA and forget to take required minimum distributions, you can be hit with a tax penalty.

Ultimately, whether to choose an annuity vs. IRA depends largely on your retirement goals. If you want the certainty of guaranteed income, an annuity can deliver. An IRA might be preferable if you’re looking for more flexibility in choosing investments.

What You Can Do Next

If you think an IRA may be the better option, weigh the pros and cons of traditional versus Roth IRAs and consider whether you’re income-eligible to contribute to a Roth. If you’d like to invest in annuity, learn more about fixed, variable and indexed options.

* As of January 2020. FORTUNE® and “The World’s Most Admired Companies® are registered trademarks of Time, Inc.

©2020 Prudential Financial, Inc. and its related entities. Used by permission. Prudential is not maintaining or updating this content and disclaims any liability to any party for the accuracy or completeness of the content.

 

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