Is an IRA an annuity? If you are thinking about saving and investing for your retirement years, then this is a question that you are likely to ask yourself, as you think about the most viable options for you. In today’s article, I will address this question and present information that I hope that you will find educative. Read on till the end to find out more.
What is an IRA?
IRA is an abbreviation for “Individual Retirement Account”, which is essentially a structure that makes it possible for investors to enjoy the tax-advantaged growth of their retirement investment assets. You can also view it as a form of protection that you put around your assets to shield them from the IRS for a period of time, or for the rest of their existence in the case of a unique type of IRA referred to as a Roth IRA.
IRAs have been perceived as a great approach to save for retirement, beyond the commonly known and utilized regular workplace retirement plans such as 401(k)s. Depending on the type of IRA and the service provider, you have more investment options to tap into, such as mutual funds and Exchange Traded Funds (ETFs). With the regular retirement plans, you may only have access to individual stocks (though this is dependent on how the plan is structured).
The two types of IRAs
Investors have two main options when it comes to investing through IRAs, which are:
Traditional Individual Retirement Accounts
Traditional IRAs are structured in such a way that they allow the investor to receive a tax break on the contributions that they make to their account. This ensures that the contributions grow tax-free so that they can be taxed later as ordinary income. You are allowed to start making withdrawals upon hitting 59 ½ years. These withdrawals are only taxed as ordinary income.
If you, however, decide to make an early withdrawal, that is before you hit 59 ½ years, then you will have to part with an extra 10% early withdrawal penalty. You also do not have to make withdrawals from 59 ½ years – the IRS allows investors to wait until they’re aged 72 years, after which they are mandated to start taking the required minimum distributions.
Roth Individual Retirement Account
The main advantage of a Roth IRA is that an investor can make tax-free withdrawals. For this to happen, however, the investor does not receive a tax break on their contributions. If you open a Roth IRA today, your assets will be allowed to grow tax-free inside the account. The other good thing about owning this type of IRA is that you will not be mandated to start making withdrawals upon hitting 72 years, hence is a good retirement plan for those who would like to leave some form of inheritance for their loved ones to enjoy.
Making a withdrawal before hitting 59 ½ years will, however, lead to you having to pay all taxes on the investment gains, as well as a 10% penalty.
**Read more about – Is an IRA Better Than a 401(k)?
What is an annuity?
An annuity is a unique insurance contract that is structured in such a way that it provides its owners with a steady income stream during their retirement years. Just like individual retirement accounts, annuities have some tax advantages as well – the money you invest grows tax-deferred until the time comes for you to start receiving payments.
The difference between an annuity vs IRA is that while an annuity is an asset that you can invest in, an IRA is a structure that you can utilize to tap into assets such as funds, stocks, and bonds.
How do annuities work?
Since an annuity is an insurance product, the owner of the annuity is required to pay premiums so that they can enjoy the protection provided by the insurer. The protection is, in this case, a steady stream of income, at the time agreed upon in the contract.
Depending on the type of annuity, the investor can pay the premiums all at once, or they can pay it gradually. The investor can also take part in the determination of the following aspects of the contract:
- When their payments will start
- How long the payments will last?
- Whether they will continue being made their partner upon their death.
What are the main factors to consider when deciding whether to open an IRA or to rely on an annuity?
It is advisable to turn to an annuity if you are looking for ways to get a steady stream of income during your retirement years, and if possible until your death. You can, however, turn to IRAs if you are looking for a way to save and invest in a bid to establish a large nest egg that you can use during your golden years.
Both annuities and IRAs present investors with impressive advantages. With annuities, you can enjoy tax-deferred growth until the time to make withdrawals comes. You will, at this point be required to pay the taxes you owe on the account’s earnings provided that you used after-tax dollars to make your contributions.
Traditional IRAs also make it possible for investors to enjoy the tax-deferred growth of their assets until they are ready to make withdrawals. Roth IRAs, on the other hand, allows you to make tax-free withdrawals, provided that your contributions were made in after-tax dollars.
If you opt to go with annuities, then the key risk you are bound to face is inflation, which will eat into your fixed dollar payments. You can counter the risk of inflation with IRAs by opening a self-directed IRA which allows for diversification. IRAs may, however, come with an investing risk that is posed by you not contributing enough funds during your working years, or failing to invest wisely. Not taking the right steps when investing using your IRA will lead to you not living comfortably during retirement.
FAQ on “annuities an IRAs?”
Which is more costly to own, annuities or IRAs?
Annuities are well-known for their hefty commissions that are eventually paid out to the salesperson involved. In some cases, you can end up paying about 10% of the amount you contributed, and while you may not pay it directly, those commissions will eventually be deducted from your returns.
Simple annuities may be generally less expensive than complex annuities, though the terms and conditions of each contract can vary, so you should be sure to understand the details regarding the fees before signing the dotted line.
Also, most annuities have a surrender period, during which the investor cannot withdraw more than the amount paid without getting hit with penalties. The surrender charges, however, seem to decrease with time.
Individual Retirement Accounts, however, attract little charges.
How are annuity rates calculated?
An annuity rate is a percentage by which an annuity grows every year. The rates are usually determined by an insurance company and will accumulate based on the regular deposits that you make to your investment. Your investment usually compounds at a stated interest rate, and there are two kinds, fixed immediate annuities, and deferred fixed annuity rates.
The fixed immediate annuities typically provide you with a fixed income stream for a period in your life by paying you some of the initial principal in addition to the interest earned each month. It is intended to provide you with income by liquidating the principal during your entire lifetime.
An immediate annuity usually has a more significant amount than other annuities since the other annuities only give you the interest that is earned from your investment. In contrast, an immediate annuity earns you the underlying investment as well. The rates offered for annuity usually depend on your age, gender, and the payout stream you choose.
Why are annuity rates so low?
There are several reasons behind the low returns from annuities. For instance, the short-term interest rates tend to be significantly higher than long-term rates. Annuity products are usually linked to long-term rates, and as such, they cannot match short-term rates. If you cash in too early, you will be penalized for it, and there are types of annuities that cannot earn any interest.
Are annuity rates going up?
In the past few years, annuity rates have started showing signs of improvement upwards. For instance, the 15-year gilt yield increased by 32 basis points to 1.46% during January 2022, and the standard annuity providers increased the rates by about 1.07%, which is expected to rise to about 2.13%. In recent years, annuity rates have been on an upward trend which is a good sign that they are, once again, becoming a promising investment.
Can annuity be cashed out?
Annuity payments can be cashed out whenever you feel like it. You can also sell some or all your future structured settlement payments for cash. However, cashing out your annuity can result in penalties such as a 10% penalty when you take funds from your annuity before 59 ½.
However, you can also sell a lump-sum dollar amount of the value of your annuity for immediate cash. Cashing out your annuity is usually not recommended before the maturity date but when you do, be sure to follow all the rules and regulations and notify the relevant parties about your decision.
Can annuity be inherited?
In case your annuity contract happens to include a death-benefit provision, you can choose a beneficiary that will inherit all the remaining annuity payments after death. However, it is also important to note that all the earnings from an inherited annuity are taxable. The beneficiary will be required to pay taxes to remain compliant with the law.
For instance, you can leave the annuity to a surviving spouse, children, or other family members. The death-benefit requirement is the main factor that determines whether the annuity can be inherited or not. It must be included in the annuity for the recipient to inherit the annuity.
Who gets an annuity after death?
For some annuities, the payments will typically end with the death of the owner of the annuity, which is also known as the annuitant. For others, there is a provision for the payments to be made to a spouse or other beneficiaries for years to come. The individual purchasing the annuity will decide on such options when the contract is drawn up.
In addition to including the death-benefit clause, they will appoint a beneficiary to who the annuity should go in the event of death. The beneficiary can be anyone from a spouse, child, or other family members, and they will stand to benefit from the annuity in the event of the death of the annuity-holder.
Are IRA fees tax deductible?
Regardless of whether you are taking distributions or not, IRA administrative fees are deductible. However, the tax will have to come out of a non-IRA fund belonging to the account owner.
In other words, your IRA fees can be taken out of your other accounts and not the IRA itself. This is because your IRA account comes with several tax benefits, which means that you will not have to get anything deducted from the IRA itself.
There are also management fees and custodian fees that have to be paid. Still, these are usually handled separately to make the process of keeping your IRA organized and adequately structured easier and more effective.
In an IRA, which investment is not allowed?
The guidelines for IRA investments are usually limited to what you cannot purchase, like collectibles and life insurance. It is also essential that you only invest in something that has an already established market.
It is not allowed to self-deal or engage in prohibited transactions since this taints your IRA transaction. The IRC sections 219, 408, and 4975, together with company regulations, will determine the allowed and prohibited investments.
For this reason, you cannot use your IRA funds to further your financial dealings, and life insurance is also not allowed. Retirement assets always require a certain level of liquidity, and as such, the investment should not be tied up in illiquid assets.
Additionally, you cannot make use of your IRA to transfer funds overseas since foreign investments are some of the investments that are prohibited for an IRA. This is because the foreign investment will put the fund outside the control of the IRS, which in a way, is a circumvention of its authority.
You can invest in real estate if the transaction is carefully structured. You must always be very careful about the allowed investments and which ones are not when investing in an IRA. You might find your funds tied up when you need them due to the investment choice you made.
What are the different types of annuities?
There are many different categorizations of annuities, but they are commonly adapted as either of the following:
- Fixed annuities
- Variable annuities
- Equity-indexed annuities
Can I customize my annuities?
Yes. The appealing factor about most annuities is that they can be customized to meet every investor’s needs. A common approach to customization is the creation of a death benefit that works in a manner similar to life insurance and whose benefits go to their beneficiaries upon the death of the investor. The one thing to note, however, is that the more features you add to the annuity, the more the fees and charges accrue.
Can I “customize” my IRA?
You cannot “customize” your IRA in a manner similar to annuities, but you can open a type of IRA known as a self-directed IRA. A self-directed IRA allows you to invest in a wide variety of assets, including those that are not supported by regular IRAs such as precious metals and cryptocurrencies.
Can I invest in cryptocurrency through an IRA?
Yes you can, this is something that have become very popular lately, retirees are investing in Bitcoin, Ethereum and also other cryptocurrencies. You can read more about how to do that on this page, and you might also want to read our post on the top-16 crypto coins to have in an IRA. Personally, I think that only a dinosaur investor would ignore Bitcoin and other cryptocurrencies as a part of their portfolio.
You might also want to read:
That will be all for today’s post in which we have addressed the question “If an annuity is an IRA?” I hope that you are now well-informed on this topic and that you know which of the two options to pick. If you still have more questions about this topic, kindly drop them in the comments section and I will get back to you ASAP.
I wish you well,
Eric, Investor and Team Member at Gold Retired!