IRA vs Annuity

Written by True Tamplin, BSc, CEPF®

Reviewed by Subject Matter Experts

Updated on August 10, 2023

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What Is an Annuity?

An annuity is a financial instrument that is designed to generate a steady income.

Annuities can be either fixed or variable and they usually pay out either monthly or annually.

Annuities were initially conceived as a way to protect widows and orphans from destitution by providing them with a guaranteed source of income.

Today they are primarily used as an investment vehicle for those who want to guarantee themselves a regular, reliable stream of income in retirement.

Deciding between IRA and Annuity? Click here.

Features of an Annuity

Guaranteed Income

This is one of the key benefits of annuities – regardless of market conditions, an annuity will continue to pay out the predetermined amount every month or year.

Protection From Creditors

With few exceptions, annuities are protected from creditors.

There is little risk that an annuity will be seized by a creditor and used to pay off debts and expenses (for example: medical bills or credit card debt).

Automatic Investment

When you purchase an annuity contract, your money goes into a fund which is managed by the insurance company.

They invest your money in stocks, bonds and other investment products with the goal of generating returns on their investment.

These earnings (along with any interest payments) go to you as income each month or year without further action on your part.

Tax-Deferred Earnings

Annuities are a tax-deferred investment.

This means that the earnings go into a separate account rather than being added to your regular income and taxed at your standard tax rate.

Tax-Free Earnings Upon Withdrawal

In addition, annuity payments are not subject to Federal or State income taxes unless they are considered to be early withdrawals.

In general, an early withdrawal refers to a request for payment before you reach age 59 1/2 years old (in some cases, this threshold can be lowered).

If you take money from an annuity prior to reaching this milestone birthday then the earnings will be subject to both federal and state income taxes plus a 10% penalty in most cases.

Multiple Payments Options

Generally speaking, annuities allow you to choose how you want your payments structured.

For example, an annuity may allow you to take a single payment following the end of each year or it might let you choose between receiving monthly payments for the rest of your life or annual payments for 20 years (with larger payouts during the early years and smaller ones later on).

What Is an IRA?

An IRA, or Individual Retirement Account is a retirement vehicle that you can use to save money when you are still employed.

The money in an IRA is invested in one of several different types of investment products (stocks, bonds, mutual funds etc.) with the goal of generating returns on their investments.

The earnings from these investments go entirely towards your retirement savings and are not taxed until they are withdrawn at age 59 1/2 years old (or later).

Features of an IRA

Tax-Deferred Earnings

The earnings that accumulate within your IRA account do so without being subject to taxes.

Tax-Free Withdrawals

If you are planning to retire early or are facing a financial emergency then one of the most attractive features of an IRA is that withdrawals can be taken out penalty free before you turn 59 1/2 years old.

Key Differences Between Annuity and IRA


Contribution Limits

Perhaps the biggest difference between an annuity and IRA is how much you can save. An IRA limits your contributions to a particular amount per year.

Any additional funds would have to be placed in a separate investment vehicle (such as a regular brokerage account).

Annuities generally do not place any limits on how much you contribute beyond the initial purchase price (although some may limit the size of monthly payments that they are willing to make).

Tax Treatment of Earnings

When it comes time to withdraw money from an IRA or other type of retirement plan (including 401(k)), earnings will be subject to Federal and State income taxes plus a penalty if taken out before age 59 1/2 years old.

This removes a great deal of flexibility from the investment.

Conversely, annuity earnings are not subject to Federal or State income taxes until they are withdrawn as well as being free from penalties if taken out early (except in some cases where they may be subject to a 10% penalty).

Purpose of the Plan

One of the biggest differences between an IRA and annuity may be how each is intended to be used.

IRAs are often for early savings and investments so that one may have a larger nest egg for retirement.

Annuities are often marketed towards people who are retired and need an additional source of income (in addition to Social Security or other forms of investment income).

Costs of Each Plan

Another key difference between annuities and IRAs is in their respective costs.

Annuities pay large commissions to salespersons which drive up the cost of their investments.

IRAs are often lower cost investments since they need to only cover the costs associated with operating their respective investment vehicles (e.g., mutual funds, stocks etc.)

Which One Is Right for You?

The right choice for you may vary depending upon your circumstances and personal preferences.

However, in general annuities tend to be better suited for investors who need a reliable source of income without having to worry about making withdrawals while IRAs are better for those who intend to leave their money invested until retirement age or beyond.

While it might seem like an easy choice between one or the other, there is very rarely an option that is perfect for everyone's circumstances; doing some extra research and thinking about your personal circumstances can help you to make a more informed decision.

The Bottom Line

Due to their tax treatment, annuities can be a great way for someone who is interested in converting some of his or her retirement investments into an additional income stream.

IRAs are quite often preferred by those who want more flexibility on how they choose to withdraw their money since you have the choice to take it out early without penalty.

It's important to do some research before making a final decision so that you can find something that will best fit with your needs and desires.

IRA vs Annuity FAQs

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.

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