What Is an Annuity?
An annuity is an insurance product that can offer a stream of payments in retirement. There are different types of annuities, but they typically involve making either a lump-sum payment or periodic payments into an account. You can elect to receive payments starting at a later date.
Types of Annuities
There are three main types of annuities: fixed, variable, and equity-indexed.
Fixed Annuities
With a fixed annuity, your payments are guaranteed not to change for the length of the payout period you select.
Variable Annuities
Variable annuities have account values that fluctuate based on the performance of the underlying investments, which can provide the potential for higher payouts. However, your payments can also go down if the investments perform poorly.
Equity-Indexed Annuities
Equity-indexed annuities offer a guaranteed minimum interest rate plus the chance to earn more based on changes in a stock market index, such as the S&P 500. This type of annuity can protect against market downturns while offering growth potential.
What Is an IRA?
An IRA, or individual retirement account, is a type of investment account that comes with tax benefits. You can contribute money to an IRA on a pre-tax or post-tax basis. IRAs come in two main types: traditional and Roth.
Traditional IRAs
With a traditional IRA, you make contributions with pre-tax money. This can lower your taxable income in the current year.
The money then grows tax-deferred, meaning you do not pay taxes on the account growth until you withdraw the money in retirement. When you do start taking withdrawals, the money is taxed as ordinary income.
Roth IRAs
Roth IRAs are funded with after-tax dollars. This means you do not get a tax deduction for your contributions. However, the money grows tax-free, and you can take tax-free withdrawals in retirement if you meet certain requirements.
Annuity vs IRA: A Comparison
Now that you know a little more about annuities and IRAs, let us compare the two.
Design
Both annuities and IRAs are designed to help you save for retirement. With an annuity, you make payments into an account and can elect to start receiving payouts at a later date. With an IRA, you make contributions to an account and can take withdrawals starting at age 59 1/2.
Tax Benefits
The tax benefits of annuities and IRAs depend on the type you choose. With a traditional IRA, you get a tax deduction for your contributions. With a Roth IRA, your withdrawals in retirement are tax-free. With an annuity, the growth in your account is tax-deferred.
Risks
Both annuities and IRAs come with some risks. With an annuity, the underlying investments can lose value, which can impact your payouts. With an IRA, if you do not contribute enough or invest wisely, you may not have enough money in retirement.
Costs
Annuities and IRAs both have costs associated with them. With an annuity, you may pay fees for the insurance company managing your account.
Commissions will also be charged if you buy an annuity through a broker. Although you are not paying this amount directly, it will come out of your returns.
An IRA typically has little to no fees. You may have to pay commissions if you buy investments through a broker. If you open an IRA at a bank or mutual fund company, there may be annual maintenance fees.
Advantages and Disadvantages of Annuities and IRA
An advantage of an annuity over an IRA is that annuities do not have contribution limits, so you can potentially put more money into your account. An advantage of an IRA over an annuity is that you have more control over your investments with an IRA.
An annuity's disadvantage is that it typically has high fees, which can eat into your investment returns.
A disadvantage of an IRA is that you may not be able to contribute as much as you can with an annuity. An IRA does not have a built-in payout control as an annuity does.
The Bottom Line
Annuities and IRAs are both retirement savings vehicles with different features and benefits. Which one is best for you will depend on your unique circumstances. It will also depend on age, investment goals, and risk tolerance.
Be sure to consult a financial advisor to see which option makes the most sense.
FAQs
1. How much can I contribute to an annuity?
There is no limit to how much you can contribute to an annuity. With this, annuities are an ideal retirement savings vehicle for high earners. The more you contribute, the more money you will have in retirement.
2. How much can I contribute to an IRA?
The contribution limit for a traditional or Roth IRA is $6,000 in 2022 ($6,500 in 2023) if you are under the age of 50. If you are over 50, the contribution limit is $7,000 in 2022 ($6,500 in 2023).
3. How do I open an annuity?
You can open an annuity through a broker, insurance company, or financial advisor.
4. How do I open an IRA?
You can open an IRA through a bank, credit union, broker, or mutual fund company.
5. What is the best type of annuity?
The best type of annuity for you will depend on your financial goals and risk tolerance. A fixed annuity may be a good option if you are looking for guaranteed income in retirement. A variable annuity may be a better choice if you are willing to take on more risk, a variable annuity may be a better choice.
