IRA vs. annuity: Which option is better for retirement?

The retirement landscape has shifted dramatically over the past few decades. Gone are the days when most retirees could count on a generous company pension to carry them through their golden years. Today’s seniors are largely on their own, left to navigate a complex web of savings vehicles, investment options and tax strategies to build the financial security they’ll need for retirement. This reality has created tremendous pressure in terms of making smart choices about where and how to invest their retirement dollars. 

As a result, retirement planning can feel a lot like assembling a puzzle. You have the pieces, but the picture isn’t clear until everything is put together the right way. And, two of those pieces — individual retirement accounts (IRAs) and annuities — represent fundamentally different philosophies about retirement planning. IRAs offer growth potential and flexibility, while annuities promise guaranteed income and protection from market volatility, making it tough to determine which approach fits your puzzle.

The challenge is that both approaches have legitimate advantages. So, how can you decide which one works best in your retirement plan? That’s what we’ll examine below.

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IRA vs. annuity: Which option is better for retirement?

At their core, IRAs and annuities tackle retirement planning from opposite directions, each with distinct advantages that appeal to different types of savers. Understanding the nuances of each retirement option can help you make a more informed decision. 

An IRA — whether traditional or Roth — is essentially a tax-advantaged investment account. You contribute money during your working years, choose from a wide range of investment options like stocks, bonds and mutual funds, and watch your balance grow over time. Traditional IRAs offer immediate tax deductions on contributions, while Roth IRAs provide tax-free withdrawals in retirement. Both types give you complete control over your investment choices and withdrawal timing, though traditional IRAs require minimum distributions starting at age 73.

As a result, the flexibility an IRA can offer is compelling. You can adjust your investment strategy as your risk tolerance changes, withdraw funds for emergencies (with some restrictions) and potentially leave a substantial inheritance to your heirs. And, if the market performs well over your career, an IRA could generate significantly more retirement income than other options.

Annuities flip this equation entirely. Instead of accepting market risk in exchange for growth potential, you’re essentially trading a lump sum of money for the insurance company’s promise to pay you a specific amount each month, either for a set period or for the rest of your life. Fixed annuities guarantee both your principal and a minimum return, while variable annuities let you invest in market-based options while still providing some downside protection.

The appeal of annuities is psychological as much as financial. With an annuity, you know exactly how much income you’ll receive each month, regardless of what happens to the stock market, interest rates or the broader economy. For retirees who are concerned about today’s volatile stock market trends, that predictability can be worth the higher fees and limited flexibility that annuities typically involve.

So, which approach wins? The answer depends almost entirely on your personal situation, risk tolerance and retirement goals. IRAs generally make more sense for younger savers who have time to ride out market fluctuations and want to maximize their long-term growth potential. They’re also ideal for people who want to maintain control over their investments and don’t mind managing their own withdrawal strategy in retirement.

Annuities, on the other hand, tend to work best for older savers who are nearing or entering retirement and want or need to prioritize income security over growth potential. They’re particularly valuable for people without access to other guaranteed income sources, like pensions, or those who worry about outliving their savings.

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When does combining an IRA and an annuity make sense?

Rather than viewing IRAs and annuities as competing options, it could make sense to take a bucket approach that uses both vehicles strategically. This hybrid strategy can help address different retirement needs while maximizing the strengths of each approach.

The most common version involves using an IRA as your primary accumulation vehicle throughout your career and then converting a portion of those savings into an annuity as you approach retirement. For example, you might keep 60% of your retirement savings in your IRA for continued growth potential and flexibility while using the remaining 40% to purchase an immediate annuity that covers your essential living expenses.

This approach creates what planners call an income floor, which is a guaranteed base level of monthly income from Social Security and your annuity that covers housing, food, healthcare and other non-negotiable expenses. Meanwhile, your remaining IRA balance can be invested more aggressively for growth, since you’re not depending on it for basic survival.

The timing of such a conversion matters significantly, however. Converting IRA funds to an annuity too early in your career means missing out on potentially decades of compound growth. Converting too late might mean you’re purchasing an annuity when interest rates are low or your health has declined enough to affect the terms.

The bottom line

The choice between an IRA and an annuity isn’t really a choice at all for most people. It’s about finding the right balance between growth and security based on your unique circumstances. If you’re decades from retirement and comfortable with market fluctuations, an IRA will likely serve you better. If you’re nearing retirement and value predictable income above all else, an annuity might be worth considering. For many retirees, though, the optimal solution involves both: using an IRA to build wealth during your working years, then strategically converting part of those savings into an annuity to create a reliable income foundation.