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Retirement Strategies: Annuity or IRA?

If you’re at all interested in saving for retirement, there’s a really good chance you’ve heard of both annuity products and IRAs. While they are two totally different tools, they have several commonalities. Both can generate income later in life and offer some potential tax advantages. But both also include penalties for early withdrawals. These two financial products also have several differences, which is what should interest you if you’re looking to add one to your retirement portfolio. Which one is right for your unique circumstances?

An IRA, or “individual retirement account,” is an account where you can purchase stocks, bonds, mutual funds and other assets to help build your retirement savings. There are two types of IRAs, traditional and Roth. With a traditional IRA, you can contribute up to $5,500 of pretax dollars annually, or $6,500 if you’re 50 years old or older. Taxes will be assessed when you withdraw funds in retirement, which may be at a lower rate. If you withdraw any money before you are 59 ½, you’ll incur penalties, however you must start taking required minimum withdrawals annually at the age of 70 ½. Contribution limits are the same with a Roth IRA, but you put in post-tax dollars, making withdrawals in retirement tax-free. Roth IRAs also provide more leniency when it comes to early withdrawals, and you aren’t required minimum distributions starting at 70 ½.

An annuity is a type of insurance where you pay premiums to get guaranteed returns later. The insurer invests your premium, paid all at once or over time, and in return pays you a guaranteed monthly, quarterly or annual payment. Payments can begin at a specific time and last a set number of years or for the rest of your life. There is a standard 10% penalty for withdrawal before age 59 ½. There are several different types of annuities, all with their own rules and details, but that’s the jist of them in a nutshell.

So which is best for your retirement portfolio? Let’s look at some pros and cons of both.

IRAs: These products are considered the workhorses of modern retirement savings, and are often viewed as the obvious (next) choice for employees who have contributed to their employer-sponsored 401(k).

Pros:

  • You keep all the gains when your investments do well and maintain control of investment decisions.
  • You can pass along your IRA to a beneficiary, like your spouse or children.
  • Fees on IRAs are generally lower and easier to understand than annuity fees.
  • You can pick the IRA that will help your unique tax situation.

Cons:

  • Investment decisions are your responsibility.
  • There’s no guarantee on how much money your investments will provide you in retirement.
  • You need to pay attention to tax rules on how much you can put in, whether you can deduct it and when to take money out.
  • If you don’t save enough, you can run out of money in retirement.

Annuities: For many, the most attractive part of an annuity product is the guaranteed cash, especially if you’ll be paying a large fixed expense, such as a mortgage, in retirement.

Pros:

  • You get a set payment you can budget with.
  • You can choose an annuity that pays for the rest of your life.
  • You can choose an annuity with a death benefit, allowing you to name beneficiaries to receive any unpaid funds.
  • Some types of annuities help high-income investors looking for a tax deferral who have already maxed out contributions to their 401(k) and IRA accounts.

Cons:

  • Inflation will erode the buying power of a set payment over time.
  • You have no say (or very limited say) in annuity investments.
  • You get a set return, so if investments do well, the insurer keeps the difference.
  • Fees are higher than IRA fees and carry potential “surrender” charges if you terminate your policy.

The biggest drawback to annuities is often identified as their complexity. They come in a wide variety, with varying time frames, payment amounts and lengths. Some of the different types of annuities include:

  • Fixed annuity: After paying a premium and a period of time passes, you get payments for a fixed dollar amount.
  • Variable annuity: This option allows you to choose some investment options, such as mutual and bond funds, but sometimes minimum loss or growth rates are set.
  • Equity-indexed annuity: These products will track, to some degree, a stock index such as the S&P 500 and guarantee minimum interest payments.

When researching annuity products, you’ll likely hear that they are “sold more than bought,” meaning that brokers are eager to sell them because they carry high commissions, rather than because they’re a great fit for the client. Unfortunately, sometimes this does seem to be the case. But that doesn’t mean that annuities are “bad” and you should steer clear. In order to protect yourself, be sure to ask a lot of questions and understand all the details before proceeding with a purchase. Shop around, as guaranteed payment quotes can vary by provider. And finally, review with a trusted financial advisor on whether an annuity is right for you.

Annuities are said to be “more sold than bought,” that is, brokers may be eager to sell annuities because they carry high commissions, rather than because they’re a great fit for the client.

Written by Rachel Summit

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