Wondering how you’ll have enough money for retirement? IRAs and annuities are two investment tools that can help.

Both offer tax-advantaged ways to fund retirement. But otherwise, they’re quite different. An IRA is a type of investment account where money can accumulate as you save for retirement. You can use it at any age. An annuity is a tool that provides you with a guaranteed income, often for life. It’s primarily for people approaching or in retirement.

Read on to learn about IRAs and annuities and how they might fit into your retirement planning.

What is an IRA?

An IRA is a flexible account that lets you save and invest for your future. You can open an IRA anytime, as long as you (or your spouse, if you aren’t working) have earned income.

Types of IRAs

IRAs generally come in two flavors: traditional and Roth. Both offer tax benefits, and which to choose largely depends on whether you want your tax break now or later.

• With a traditional IRA, you can deduct contributions from your current taxable income. Depending on where you hold the account, your investment choices could be limited to, say, specific mutual funds—or open to almost any investment on the market. The account grows tax-deferred. You owe income tax on the money you withdraw from your IRA in retirement.
  
• With a Roth IRA, you contribute after-tax dollars—money you’ve already paid income taxes on. The benefit: You won’t owe tax or penalties when you withdraw, presumably in retirement, as long as you’ve held the account for at least five years and met other criteria.
  

Which type of IRA to choose often comes down to whether you think your tax bracket will be higher or lower when you withdraw than when you contribute. If you’re not sure—or you want to hedge your bets—you can contribute to both, as long as you don’t exceed the combined annual contribution limits: For 2024, that’s $7,000 (or $8,000 if you’re over age 50 or will be by year-end) and your income falls below IRS limits.

IRA advantages and drawbacks

What’s an annuity?

An annuity is a tax-deferred insurance contract that can provide a guaranteed income stream, often for life. Social Security and pensions are also types of annuities.

Knowing how much money you’ll have available to spend can help you budget in retirement. Combined with income from other sources, such as an IRA or 401(k), an annuity can help protect and sometimes even increase your total retirement income.

You can buy an annuity, typically from an insurance company, with a single lump sum or pay into it over time. Your employer may also offer annuities in a 401(k) or, more commonly, 403(b) plan Open in new tab. (The SECURE Acts Open in new tab of 2019 and 2022 made it easier for 401(k)s to include lifetime income annuities.) Depending on the type of annuity, the insurer invests your money both to gain value over time and to protect your investment.

Deferred vs. immediate annuities

• You buy a deferred annuity at least a year before you plan to start taking income. You can set up a regular contribution schedule, paying into the annuity until it’s time to take payments, typically in retirement. The period between when you buy the annuity and when you begin taking payments is called the “accumulation” period.
  
• Because it pays out right away, an immediate annuity has no accumulation period. You’ll need a lump sum to purchase this annuity type. (You can tap your retirement accounts or other assets for that.)
  

In each case, the “annuitization” phase begins when you start receiving payments. Depending on the type of annuity, you’ll get guaranteed income for either a set period (such as 20 years) or for the rest of your life (as with Social Security).

Also, different annuities have different terms and conditions. For instance, they may penalize you if you withdraw money before your annuitization payments begin. Also, if you’re married, you can choose between two types of monthly payments: Larger “single life” payments end when you die, while smaller “joint life” payments continue to go to your surviving spouse for the rest of their life.

Different kinds of annuities

To decide whether an annuity may be right for you, investigate what’s available. Not every insurer offers every type. By understanding your choices, you can more easily find an annuity that fits your needs.

Fixed vs. variable annuities

In general, fixed annuities give you more certainty—you have a pretty good idea of how much income you’ll generate based on how much you contribute. By contrast, variable annuities can generate higher earnings, but they also come with more risk and uncertainty, especially when markets are volatile.

• A fixed annuity guarantees your principal—the amount you contribute—and offers a set interest rate over a defined period.
  
• A fixed indexed annuity offers more opportunity for your money to grow than a fixed annuity but less potential return than a variable annuity. With this annuity, you can allocate to a fixed-rate strategy, which grows at a set interest rate and/or to index-based investments, where performance is based on how well those investments do. Basically, a fixed indexed annuity incorporates elements of both a fixed and an indexed annuity: It protects your money from loss but offers it more ways to grow than a fixed annuity.
  
• As the name implies, a variable annuity’s performance can change over time. It invests in the stock market, but it’s not limited to certain indexes. This can give you opportunities to earn more if the market does well—but you could lose money if it doesn’t. (Some variable annuities do offer protection against market downturns, usually at an extra cost.)
• An indexed variable annuity’s value is based on the performance of an index: a group of stocks that represent a portion of the market, such as the S&P 500^® list of large U.S.-based companies. This annuity product limits both upside (gains) and downside (losses) potential: You may get some protection from market drops, but also a cap on returns.

What benefits and risks do annuities offer?

Like any investment type, annuities have both potential benefits and risks.

Are annuity payouts taxable?

Generally, part of your annuity payout is taxable. The way that the money is taxed depends on how you fund the annuity.

A qualified annuity is funded with pretax dollars—typically money from a 401(k) or IRA. The annuity’s earnings and interest accumulate tax deferred. Withdrawals are taxable at your current income tax rate. Once you start taking income, it’s taxable. (That could happen sooner than you think: Starting at age 73, you may face required minimum distributions [RMDs] from traditional IRAs or 401(k)s; to defer those RMDs, you may be able to roll over up to $200,000 from a traditional IRA or 401(k) into a qualified longevity annuity contract (QLAC) and start taking income as late as age 85.)

A nonqualified annuity is funded with after-tax dollars. Because you’ve already paid taxes on that money, you’ll owe income tax on any gains the annuity makes once you start taking income. (An “exclusion ratio Open in new tab” determines what portion of your payments are tax-free.)

Differences between annuities and IRAs

Annuities and IRAs have a fundamental difference. An annuity is a tool for providing guaranteed income. An IRA is designed to help you accumulate money to fund retirement.

Both vehicles offer tax benefits and may have fees. Variable annuity fees may be higher than those charged by other kinds of investments.

Annuities and IRAs also come with risk. With an annuity, you run two risks: Inflation may erode the value of your income, and the insurer itself could fail. (You could also lose money with certain annuities.) For IRAs, the risk is in the investments you choose.

Can you roll an annuity into an IRA, or vice versa?

Yes. You can roll a traditional individual retirement account balance directly into a qualified annuity. (A Roth IRA can be transferred into a Roth IRA annuity.)

Annuity vs. IRA for retirement

Are you better off with an annuity or an IRA for retirement? Would a combination better fit your situation? The answers depend on your age, your finances, and your retirement goals. Consider:

• Annuities are increasingly part of employer-sponsored 401(k) retirement savings plans. (403(b) plans, aka tax-sheltered annuities, or TSAs, have had them for years.) Purchasing annuities outside those plans usually doesn’t make sense for younger savers. IRAs (along with workplace plans) have greater long-term growth potential: The more time you have until you’ll need your money, the more risk you can afford to take in seeking greater rewards. And don’t forget the power of compounding over time.
  
• If you want or need guaranteed deferred or immediate income, look to an annuity. (Some annuities can also provide growth, but generally not as much as with an IRA.) If tax-free income is your goal, a Roth account (at work or via an IRA) could suffice.
  
• An IRA offers more potential investment growth, but it can’t guarantee income or protect your principal.
  
• Remember that you can use an individual retirement account balance to fund an annuity and create a guaranteed stream of lifetime income.
  

If the idea of an annuity appeals to you, do your research Open in new tab, and check insurers’ financial strength ratings Open in new tab. Read an annuity contract carefully to ensure that the terms are a good fit for your needs.

Footnote

*Annuity contracts are sometimes known as "individual retirement annuities.” You should speak with your tax advisor regarding your situation for details.

Author details

Ingrid Case is an award-winning journalist and ghostwriter. Her work has appeared in Bloomberg Markets, Money, Financial Planning, and others.

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