What's the difference between an individual retirement account (IRA) and an annuity?
An IRA is a type of account that people save money in and provides tax advantages (various depending on type of IRA, ROTH, Traditional). Some people confuse it for a type of investment. It is actually more of a vehicle that allows you to hold the investments with the various tax advantages. People commonly invest in stocks, bonds, and mutual funds inside the IRAs. Other options are sometimes available but can get complicated and messy. The IRS places some income limits on tax benefits of IRAs as well as contribution limits. See here for more info on that... https://www.irs.gov/retirement-plans/individual-retirement-arrangements-iras-1
Annuities are contracts with insurance companies. They often come with some level of guarantee, but typically at a much higher fee. A fixed annuity will pay out a predetermined amount based on the contract. A variable annuity allows you to invest money in the market (stocks, bonds, funds...). Annuities don't have income/contribution limits. They do have similar tax advantages as an IRA (tax deferred growth until you withdraw the money). Here is some info about taxation and annuities. https://www.irs.gov/publications/p575/
Both provide potential tax advantages/deferred growth. Both have penalties for withdrawing money prior to 59 1/2. Things to consider when debating between the two: age, income levels (current and future), FEES, credit worthiness of insurance provider, your risk tolerance, your level of involvement you desire...
At the end of the day, you should understand what you're buying, the fees, and the risks before taking any action.
Great question because there are some similarities. First, the IRA rules are described in detail here https://www.irs.gov/retirement-plans/individual-retirement-arrangements-iras-1.
The intent is to promote retirement savings by providing some tax advantages. For many people, contributions that they make to IRAs are “pre tax”, meaning that they can take a deduction for their contribution on the tax return the same year the contribution is made. They save taxes in doing so. The account grows tax deferred. Thus, for many, there are two big ways to benefit from a tax perspective. Be aware of the traditional IRA income limitations for both regular as well as Roth IRAs. There are also limitations on withdraws, however, and this is similar to the rules for non-qualified deferred annuity contributions in that penalties apply if you are not age 59 ½. While there are some exceptions to the premature distribution rules, remember that one of the benefits of these types of plans is that they promote ‘long term savings’. We find it pretty easy to put and take into taxable savings accounts, the trick is to ‘put and keep’ the money growing for you in the longer term and for a time when you will not have as much earned income.
The periodic savings program into a tax deferred annuity does not offer the same “up front” tax advantage. The earnings grow tax deferred, however, so there is a tax benefit from the tax deferred accumulation. Withdrawals do carry a penalty if made prior to age 59 ½ and there is also a tax treatment that is referred to as “LIFO,” meaning that earnings come out and are taxed first until you begin to recover your basis or contribution amounts. http://www.investopedia.com/ask/answers/082715/how-are-nonqualified-variable-annuities-taxed.asp
Charlotte Dougherty is a registered representative of Lincoln Financial Advisors, a broker/dealer (Member SIPC) and a registered investment advisor. Lincoln Financial Advisors does not provide legal or tax advice. CRN1630730-102816.
It really depends on your purpose. If you want to simply defer tax, then both vehicles can do that. In fact, if you have maxed out all retirement savings, such as 401(k), IRA, and HSA, but still want to defer tax further, you can use an annuity for that purpose.
On the other hand, if you haven’t fully contributed to your 401(k) or IRA, you may want to stay away from the annuity unless you’re near-retirement. Why? When people are close to the retirement or already in the retirement, they want to safeguard their nest egg and/or need some form of a lifetime payment. In that case, an annuity may be considered. You can work with a CFP® or RICP® to figure it out which type of annuity may benefit you the most.
An IRA is a type of account and an annuity is a product.
An annuity can be held in an IRA, just as stocks, bonds, and mutual funds can, or it can be held in a non-retirement account. Both annuities and IRAs offer tax-deferral benefits and if you were to withdraw funds from either an annuity or an IRA prior to age 59 1/2, you would be subject to a 10% penalty.
In terms of differences between the two, while there are annual contribution limits for IRAs, there are not contribution limits for annuities. Additionally, whereas IRA owners are required to take minimum distributions from IRAs once they reach age 70 1/2, if an annuity is owned in a non-retirement account, it is not subject to minimum distribution requirements.
Night and Day. An IRA is a covered by Title 26 of the US Code of Federal Regulations which means that it is a type of Qualified account. When you set it up, you qualify for an income tax deduction (if you meet the thresholds) for your contribution, and the earnings grow tax-deferred. The intent is that the monies are to be used for your retirement in your 60's, so the IRA imposes an early surrender penalty of 10% + income taxers if you withdraw the monies before then.
An annuity is not a qualified account. You get no tax deduction for setting it up, but the earnings do grow tax deferred indefinitely. If you're under 59 1/2, you'll have to pay a 10% penalty to withdraw funds (in most cases) and the income is taxed as ordinary income.
It is sometimes confusing because some people can buy tax-deferred annuities inside of a tax-deferred IRA account. The IRA account is the "vehicle" and the annuity is the product or gasoline that runs the vehicle.
You are limited as to how much money you can put into an IRA account, but there is no limit to how much you can contribute to an annuity.
Annuities and IRAs are powerful financial planning tools. I have clients that have maxed out the total allowable 401(k) and IRA contributions ($53,000) and still have money left over. In this case, they'll purchase investment-grade annuities with low fees and expenses to grow their tax-deferred savings even more.