Annuity vs. IRA: Main differences, how to choose the one for you

Both annuities and IRAs are tools to help you prepare financially for retirement. Because they are different products — an IRA is an investment account while an annuity is a contract between you and an insurer — there are key differences in how they work.

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Tory CrowleyAssociate Editor & Licensed Life Insurance AgentTory Crowley is an associate life insurance and annuities editor and a licensed insurance agent at Policygenius. Previously, she worked directly with clients at Policygenius, advising nearly 3,000 of them on life insurance options. She has also worked at the Daily News and various nonprofit organizations.

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Antonio Ruiz-CamachoAntonio Ruiz-CamachoAssociate Content DirectorAntonio helps lead our life insurance and disability insurance editorial team at Policygenius. Previously, he was a senior director of content at Bankrate and CreditCards.com, as well as a principal writer covering personal finance at CNET.

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Annuities and individual retirement accounts (IRAs) are financial tools that can be helpful as you plan for retirement. Both annuities and IRAs offer tax advantages that can help you plan for financial security during your golden years. However, annuities and IRAs are fundamentally different products that offer different advantages. 

An IRA primarily functions as a savings vehicle. You’ll put money in your account over time, with the goal of accessing it after you turn 59 ½ years old. An annuity is an insurance contract that is usually used to create a guaranteed stream of income, often for the rest of your life. 

You can hold a wide array of savings and investment accounts in an IRA — including an annuity. This allows you to save and manage a stream of income for retirement income while maximizing tax benefits. 

Key takeaways

  • Both IRAs and annuities offer a tax-advantaged way to save for retirement.

  • An IRA is an account that holds retirement investments, while an annuity is a contract between you and an insurance company.

  • An IRA generally functions as a savings mechanism, whereas an annuity can provide a guaranteed stream of income in exchange for a series of payments, or one large payment. 

  • You can hold an annuity inside of an IRA to combine their features for maximum benefit.

What is an IRA?

“IRA” is short for individual retirement account. Most people set up an IRA during their working years and contribute to it over time. Then, when they retire, they’ll access those funds and use them for their living expenses. 

While you’re saving money in an IRA, you can invest that money in many ways, including through stocks, bonds, mutual funds, certificates of deposit (CDs), or annuities. This money will grow tax-deferred until you’re ready to start drawing from it.

How does an IRA work?

An IRA offers a relatively high degree of flexibility on how it’s managed. You can choose how the money in your IRA account is invested. For example, if you’re more risk-tolerant, you can invest your IRA funds in stocks, and if you're more risk-averse, you can invest your IRA money in CDs. 

However, with an IRA, there are annual contribution limits. As of 2023, you can’t invest more than $6,500 per year, or $7,500 if you’re age 50 or older. [1] For many people, this may not be enough to fund their retirement, so you may need to plan for another source of retirement income as well. 

You can begin withdrawing money from an IRA when you reach age 59 ½. If you withdraw money prior to this, you’ll pay additional fees and taxes. 

What are the different types of IRAs?

There are two common types of IRAs that most people choose between: Traditional IRAs and roth IRAs. Choosing which is best for you will depend on your overall financial needs. 

Traditional IRAs

If you set up a traditional IRA, you’ll make deposits using pre-tax dollars. Later, when you collect money from your IRA, you’ll pay taxes on any withdrawals you make. 

Traditional IRAs are best suited for people who expect to make the same or less money when they start withdrawing money from their IRA. 

Roth IRAs

You’ll fund a Roth IRA with post-tax dollars. So when you’re ready to make withdrawals, you won’t have to pay taxes on the money you collect from your IRA. 

Roth IRAs are best for people who expect to be in a higher tax bracket when they collect money from their IRA, because the IRA will minimize the amount of taxes they pay.

Are IRAs considered annuities?

IRAs are different from annuities. However, because they’re both tax-deferred savings vehicles, they can work in tandem to provide you with a robust financial plan, especially during your retirement years. 

Remember that you get to determine how the money in your IRA is invested. So you can choose to invest your IRA funds into an annuity, allowing the two tools to work together.

What is an annuity?

An annuity is a contract between you and an insurance company. You’ll purchase an annuity with premiums, and then the annuity will pay you in the future, usually in the form of regular payments. It’s common for people to use retirement savings — such as an IRA or 401(k) plan — to fund an annuity to create an income stream for retirement.

How does an annuity work?

You’ll pay to finance an annuity and the money you put into an annuity will then be used to pay you an income at a later date. You can set up an annuity to pay you a certain amount of money, for a certain period of time, or for the rest of your life. 

Annuities can protect you financially during your retirement years, to ensure that your savings don’t run out — something that could eventually happen with IRA funds invested in CDs or stocks, for example. An annuity could be a good fit for you if you’re “looking for additional benefits such as guaranteed income or guaranteed death benefits and you don’t need access to those funds immediately,” says Tony Boyden, learning and development partner at Zinnia. 

Learn more about how annuities work

What are the different types of annuities?

There are different types of annuities based on how the money in the contract grows. You can set up your annuity to grow based on your risk tolerance. 

Fixed annuities

With a fixed annuity, your annuity payments will be guaranteed to be the same for the entire duration of your contract. Your money will grow at a low, guaranteed return rate. “Fixed annuities get the upside of market growth with no downside risk,” says Amy Shirk, sales associate at Policygenius. This means that you won’t have to worry about losing money, but you’ll give up the chance for your money to be invested more aggressively. 

Fixed annuities can be a good choice for people looking for consistent, reliable sources of income during their retirement years. 

Indexed annuities

Indexed annuities grow with a bit more risk compared to fixed annuities. A portion of the annuity will be tied to the performance of an index such as the S&P 500. This means if the market does well, it will correlate to your annuity increasing. If the market goes down, you may earn less, but you won’t lose any money. To be able to offer some security in your investments but more growth potential than fixed annuities do, indexed annuities usually come with participation rates, return caps, and loss floors.

Variable annuities

Variable annuities offer the most aggressive investment options. Your payments will be tied directly to the investment performance of the stocks, bonds, or index funds your annuity is invested in. Your return potential will be greater than with indexed or fixed annuities if the market performs well, but your funds could also lose value during a market downturn. Variable annuities could benefit those who have a higher risk tolerance and are more savvy in understanding how to monitor the performance of different investment products. 

Learn more about fixed annuities vs. variable annuities

Are annuities considered retirement accounts?

Annuities are insurance products — not retirement accounts. However, you can use annuities in conjunction with a retirement account like an IRA to maximize your financial benefits to best meet your needs. 

Learn more about other types of annuities

What are the main differences between IRAs & annuities?

IRAs and annuities are fundamentally different financial tools, so they’ll operate differently. Make sure you understand how each one works as you’re considering an IRA or an annuity. 

Purpose

The main purpose of an IRA is to generate savings for your retirement years, whereas the main purpose of annuities is to manage your money and guarantee a stream of income payments during your retirement years. 

Investment options

An IRA will allow you to invest the money in many ways, including CDs, bonds, mutual funds, stocks, and even annuities. If you have an annuity, you can choose fixed, indexed, or variable accounts, depending on how risk-averse you are. 

Tax benefits

Both IRAs and annuities offer similar tax benefits. With both, you’ll either fund the account with pre- or post-tax money, and you’ll only have to pay taxes once. You can strategically fund your account to limit the amount of taxes you’ll pay over your lifetime. 

With both IRAs and annuities, your money will grow on a tax-deferred basis. If you fund your annuity contract with pre-tax dollars, it will be considered a qualified annuity. If you fund it with after-tax dollars, it will be a non-qualified annuity.Costs

With both IRAs and annuities, you’ll pay administrative fees and you could be subject to surrender or withdrawal fees if you withdraw money from your account early. 

With both an IRA and an annuity, if you need to withdraw money early, you could pay a 10% penalty on top of the taxes you owe. [2]

Risks

Generally speaking, both IRAs and annuities offer low risk. However, with both tools, you can customize your choices to take on higher risk and potentially higher growth. For example, you can choose to invest an IRA in stocks, which can grow faster but also offer greater risk. Likewise, you can set up a variable annuity, offering the greatest risk and greatest potential reward. 

Alternatively, if you’re risk averse, you can invest your IRA more conservatively, like in a CD. And you can choose a fixed annuity, which offers a low, but reliable rate of return.

Can annuities be used as a collateral for a loan?

Liquidity vs. guaranteed income

Annuities offer in general fewer liquidity options than IRAs. In most cases, annuity contracts provide a guaranteed stream of income in exchange for giving up access to your funds at any time. 

If you need access to a large portion of your annuity’s principal or accumulated value during an emergency, you may have to pay surrender fees or other high penalties — and, in some cases, you may not be able to have access to your funds beyond your guaranteed income payments at all. Depending on the type of investments you have in an IRA, you may be able to access your funds more easily or without having to pay large fees at any time.

At the same time, an annuity can offer the peace of mind of securing a stream of income for the rest of your life — you don’t need to worry about outliving your savings. Depending on how you invest and spend the money on an IRA, you may run out of retirement savings while you’re still alive.

Immediate vs. deferred annuities: Comparing the main differences

Feature

IRAs

Annuities

Purpose

Savings

Payments

Investment options

CDs, bonds, mutual funds, stocks, and annuities

Fixed, indexed, variable

Tax benefits

Grows tax-deferred

Grows tax-deferred

Costs

Administrative and transaction fees

Administrative fees and surrender charges

Risks

Generally low risk, although you can make more aggressive, high-risk investments

Generally low risk, although you can make more aggressive, high-risk investments

Liquidity

More flexible, depending on investments

Limited to none

Income payments

Not guaranteed

Guaranteed, often for the rest of your life

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Who should consider an annuity?

An annuity is a good option to consider as you’re approaching retirement. Annuities take a large sum of money and organize them into manageable payments that you can rely on. 

It’s common for people to use their retirement savings from an IRA or other retirement account to buy an annuity to fund their retirement. 

Are annuities a good investment?

Who should consider an IRA?

If you’re looking for a way to build savings for your retirement years, setting up an IRA can help with this. IRAs allow you to save money with either pre- or post-tax dollars, depending on what makes the most financial sense for you. 

You can also determine how the money in your IRA will be invested, so you can arrange to have it grow with tools in accordance with your risk tolerance. 

How to decide between IRAs & annuities? 

Deciding between an IRA and an annuity will largely depend on your current life stage, rather than trying to choose between two similar products with similar function. 

If you’re looking for a way to save money and build a financial safety net toward retirement, an IRA can be an effective tool in your financial planning. If you have some money saved and you’re looking to manage these funds to create a reliable income for your retirement years, an annuity could be a good option for you.

If you’re not sure whether an IRA or an annuity, or a combination of both could work for you, speak with a financial advisor who can offer you transparent, unbiased advice.

Explore other annuity options

References

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Policygenius uses external sources, including government data, industry studies, and reputable news organizations to supplement proprietary marketplace data and internal expertise. Learn more about how we use and vet external sources as part of oureditorial standards.

  1. IRA

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    IRA FAQs

    ." Accessed May 30, 2024.

  2. IRS

    . "

    Publication 575 (2023), Pension and Annuity Income

    ." Accessed May 30, 2024.

Author

Tory Crowley is an associate life insurance and annuities editor and a licensed insurance agent at Policygenius. Previously, she worked directly with clients at Policygenius, advising nearly 3,000 of them on life insurance options. She has also worked at the Daily News and various nonprofit organizations.

Editor

Antonio helps lead our life insurance and disability insurance editorial team at Policygenius. Previously, he was a senior director of content at Bankrate and CreditCards.com, as well as a principal writer covering personal finance at CNET.

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