Annuity vs. IRA: Which Is Better for Retirement?

Quick Answer

Annuities and IRAs both help you fund your retirement. IRAs are tax-advantaged savings and investment accounts. Annuities are contracts that offer guaranteed payments. Both have pros and cons, and should be considered as part of a larger retirement plan.

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Annuities and individual retirement accounts (IRAs) are both vehicles for generating income in retirement, but they each offer a different set of potential benefits. IRAs are tax-advantaged accounts that let you save and invest flexibly. Annuities offer guaranteed payments, which can provide a welcome measure of predictability when you're retired.

Which is the better retirement investment, an annuity or an IRA? As you might expect, the answer depends on your goals and risk tolerance. Read on for more about IRAs, annuities and how each one might help you fund your retirement.

What Is an IRA?

An IRA is a tax-advantaged account that helps you save and invest for retirement. Tax advantages may include tax-deductible contributions, tax-free or tax-deferred growth, or tax-free withdrawals, depending on the type of IRA you own. Anyone with taxable income can open and fund an IRA. They're widely available through mutual fund companies, brokerages, banks and credit unions.

Types of IRAs

The two main types of IRAs are traditional IRAs and Roth IRAs. Both are tax-advantaged retirement accounts, but they save you money in different ways.

  • Traditional IRAs allow you to use pretax dollars to fund your account. You deduct the amount of your contributions annually on your tax return. Your money grows tax-deferred while it's in your account. When you withdraw your money in retirement, you pay ordinary income tax on your withdrawals.
  • Roth IRAs are funded with after-tax dollars. You don't get a tax deduction for your contribution, but your money grows tax-free while it's in your account, and your qualified distributions are tax-free as well.

Regular income taxes and a 10% early withdrawal penalty apply when you withdraw money from a traditional IRA before you reach age 59½. Because Roth IRAs are funded with after-tax dollars, early withdrawal penalties only apply when you withdraw your earnings, and not to the principal you contributed to the account.

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Pros and Cons of IRAs

IRAs are a staple for retirement savers and investors. Their flexibility and wide availability make them an easy choice. Here are a few pros and cons of using IRAs to save for retirement.

Pros

  • Tax-advantaged investing
  • Easy to open
  • Many investment choices
  • Flexibility: Change investment choices or contribution amounts anytime

Cons

  • Have contribution limits
  • Investments may carry a risk of loss
  • Unpredictable gains

What Is an Annuity?

An annuity is a contract between you and an insurance company. You provide money, either upfront or in payments, and the insurance company agrees to issue payments to you. You may receive your payment as a lump sum, as a fixed number of payments (for example, 120 payments over 10 years) or for the rest of your life. Some people use annuities to guarantee they'll receive income without running out of money in retirement.

Tax rules vary depending on the provisions in your annuity contract. Annuities are typically tax-deferred, meaning you won't pay taxes on interest or earnings until you withdraw your money. If you funded a qualified annuity with pretax dollars through an employer-based retirement plan, your withdrawals are taxed as regular income. If you bought your own annuity with after-tax dollars, you'll pay taxes on the portion of your payment that consists of interest or gains (but not the principal you originally provided).

Annuities are available from insurance companies, brokerages and some mutual fund companies, banks and credit unions. Annuity contracts can be complicated, so give yourself plenty of time to understand how your annuity works before you sign on the dotted line.

Types of Annuities

Although there are many types of annuities and specific provisions within each contract, these are some of the most common types and features you may see:

  • Fixed annuity: Promises a minimum interest rate, which means your annuity's value may grow without risk of decline.
  • Variable annuity: Allows you to direct your money into different investment options, such as mutual funds. Payments can vary depending on what you invest, your rate of return and expenses.
  • Indexed annuity: Ties your rate of return to a market index, such as the S&P 500. An equity-indexed annuity (EIA) offers a guaranteed minimum interest rate combined with interest tied to a market index. A registered index-linked annuity (RILA) doesn't offer a guaranteed minimum interest rate; instead, your returns may have a "floor" that limits your downside and caps that limit your upside potential.
  • Lifetime annuity: Makes fixed payments for the life of the annuitant. Even if you live to be 120 years old, you won't run out of payments.
  • Fixed period annuity: Pays benefits over a fixed period of time, for example over 10 or 20 years.
  • Immediate annuity: Begins scheduled payments immediately after the annuity is purchased. Immediate annuities are usually purchased with a single payment, which enables payouts to begin right away.
  • Deferred annuity: Doesn't begin payments until a designated period of time has passed. Deferred annuities are often set to begin payments in retirement.

Pros and Cons of Annuities

How do annuities stack up against IRAs? There are similarities, but many pronounced differences as well. Here's a quick rundown on pros and cons.

Pros

  • Guaranteed payments that may not be dependent on market performance
  • Diversification of your retirement portfolio
  • Additional investment possible after you've maxed out your IRA contribution
  • No contribution limits

Cons

  • Narrower range of investment options
  • Interest may not keep up with inflation
  • Potential high fees and commissions
  • Surrender penalties can make annuities less liquid
  • Not insured by the FDIC, NCUA or SIPC, as many IRAs are
  • Options may be limited if the insurance company goes out of business. Check rating sites like A.M. Best or Moody's to learn about the company's health, and find your state's guaranty organization on the National Organization of Life & Health Insurance Guaranty Associations website to learn more about protections in your state.

Differences Between Annuities and IRAs

If you're considering an annuity or an IRA for your retirement plan, think about how each of these tools function. An annuity might be a good investment if you want guaranteed income to supplement your Social Security or pension. An IRA gives you the flexibility and resources to meet unexpected expenses as they arise—and to maximize your gains when markets are strong.

Here are some key differences between annuities and IRAs. Bear in mind that some of these descriptions may not apply to all annuities and IRA accounts, but only to specific types.

Annuity vs. IRA
Annuity IRA
Converts savings into guaranteed payments Invests savings for long-term growth
Limited investment choices Wide range of investment choices
Tax-deferred interest and gains Tax-deductible contributions with a traditional IRA; tax-free withdrawals with a Roth IRA
No contribution limits

Contributions limited to $7,000 ($8,000 if you're 50 or older) in 2024

Guaranteed payments based on the timeline you choose Required minimum distributions for traditional IRAs start at age 73
Surrender fees and a 10% early withdrawal penalty if you're under 59½ when you take a distribution 10% early withdrawal penalty if you're under 59½ when you take a distribution
Guaranteed fixed payments are not dependent on market performance Market performance largely determines gains and resources available in retirement
Both gains and losses may be capped Gains and losses are typically not limited

The Bottom Line

Which is the better retirement vehicle for you, an annuity or an IRA? Because they offer tax advantages and flexibility, traditional and Roth IRAs fit a wide range of retirement planning needs. If guaranteed payments are important to you—for a specific purpose or simply for peace of mind—an annuity can provide long-term or even lifelong predictable income.

Consider your whole retirement picture. How will Social Security, pension benefits such as 401(k)s, retirement savings and tools like annuities work together to support you in retirement? If doing these projections and calculations is challenging, you may want to work with a retirement planner. A qualified financial professional can help you decide which choices are right for you, and help you structure a portfolio that balances predictable income against maximum gains.