Is an Individual Retirement Annuity Different from an IRA?

Yes, individual retirement accounts (IRAs) are investment vehicles that can hold a variety of investment assets, like stocks, bonds, cash, and even annuities. Individual retirement annuities are investment vehicles that can only hold fixed or variable annuities.

IRAs and individual retirement annuities are both primarily used for retirement planning — building up a nest egg to support you once you stop working. They are also similar to each other in that they can both hold other assets.

They differ in what assets they can hold, how they work, their fee structures, and more. These differences mean the risk profiles can vary significantly and may suit different types of people at different times of life.

In this article, you’ll learn the difference between IRAs and individual retirement annuities and how to choose the right one.

What Is an Individual Retirement Annuity?

Individual retirement annuities are investment vehicles that you buy from life insurance companies or annuity companies. They can hold either fixed annuities or variable annuities inside of an individual retirement annuity.

In addition to offering guaranteed income, individual retirement annuities offer significant tax advantages. For many, these can be a powerful option for diversifying an investment portfolio and securing a guaranteed retirement income.

Because IRAs and individual retirement annuities are both investment vehicles aimed at helping individuals build their retirement savings, people commonly confuse the two. The fact that they both can be abbreviated to “IRA” doesn’t help! While there are a few similarities, they have important differences that make them appropriate for different types of people.

Individual Retirement Annuity vs. Individual Retirement Account (IRA)

The key difference between IRAs and individual retirement annuities is the types of assets that they can hold. The IRA is much more flexible. It can hold virtually any kind of asset, from stocks, bonds, certificates of deposit (CDs), and mutual funds, to other annuities and even real estate.

In contrast, the individual retirement annuity is much more restrictive. It can only hold fixed annuities and variable annuities. Annuities are typically quite safe places to put your retirement money, so individual retirement annuities tend to have low-risk profiles. IRAs can hold many different types of investments, and the portfolios they hold are often higher risk than individual retirement annuities.

Note, though, that the risk profile ultimately depends on the investments inside each vehicle. An IRA that holds bonds and CDs may be lower risk than an individual retirement annuity that holds a variable annuity.

Another difference is what they offer. One of the unique features of annuities is that they offer a guaranteed lifetime income. That means that you can choose a payout option from your annuity where you receive periodic payments for the rest of your life.

In contrast, IRAs are simply a tax-advantaged way to invest for retirement. While you can organize your IRA to take regularly scheduled distributions, you don’t have to. More importantly, they can’t guarantee you income for the rest of your life. Only annuities can offer that.

How Do Individual Retirement Annuities Work?

An individual retirement annuity is much like any other annuity.

You buy an annuity insurance product from a life insurance company. With most annuities, you can choose to pay your premiums (payments) in a single lump sum or in smaller payments over time. With individual retirement annuities, there is no lump sum option. You are always given a flexible premium option so you can make premium payments over time.

While you are paying your premiums, the value of your annuity account is accumulating, and your money earns interest. The interest crediting rate that you receive depends on the type of annuity you choose. With a fixed annuity, you receive a fixed minimum interest rate. With a variable annuity, the rate is tied to the performance of a set of underlying investments that you choose. Variable annuities are riskier because their rate of return is influenced by external factors, like stock market performance.

When you’re ready, you can choose to annuitize the annuity and start the “payout” phase. During this period, you receive your regular annuity payments. You can usually choose to receive your payments for a set period of time — say, over 10 years — or receive your annuity income for the rest of your life.

Many annuities also offer optional add-ons or riders. Thesecommonly include death benefits, a joint life annuity to include a spouse, and cost of living riders (COLA).

Available in Both Traditional and Roth Structures

Both individual retirement annuities and IRAs can be implemented in either a “traditional” or “Roth” version.

Traditional structures. In a traditional IRA or individual retirement annuity, you contribute with pre-tax dollars. That allows you to take a deduction in the year the contribution is made, and your taxes are deferred until the year you make withdrawals. With this version, you are not able to make early withdrawals before you are 59½. If you do, you could face a 10% tax penalty.

Roth structures. In a Roth IRA or individual retirement annuity, you contribute with after-tax funds. Because you already paid taxes on your money, you don’t pay taxes on it again when you receive your withdrawals. However, you will pay taxes on any earnings. With a Roth structure, you’re also able to withdraw your money at any time without a tax penalty.

Note: There still may be early withdrawal fees, or surrender charges, charged by the annuity company if you take your money out of an annuity before the term is over. These could apply to either the traditional or Roth individual retirement annuity.

Similar Contribution Limits to IRAs

There are limits on how much you can contribute to an IRA each year. In 2021 and 2022, the annual contribution limit set by the Internal Revenue Service (IRS) is $6,000 if you’re under 50 or $7,000 if you’re over.

Individual retirement annuities also have contribution limits. Conveniently, they’re the same as the limits for IRAs: $6,000 for people under 50 or $7,000 for people over 50.

Subject to Similar Distribution Guidelines as IRAs

The IRS has also set out rules for receiving distributions from an IRA. These same rules apply to individual retirement annuities.

First, withdrawals are subject to ordinary income tax at the income tax rate that’s applicable in the year the withdrawals were made. To reduce your tax burden, it can be useful to delay withdrawals until years when your income tax is lower. (For Roth IRAs and Roth individual retirement annuities, you won’t pay taxes on your contributions, just on any interest you earned).

Second, early withdrawals may face a 10% tax penalty. The penalty applies to most withdrawals from a traditional IRA or individual retirement annuity before age 59½. It’s a bit different for Roth IRAs and individual retirement annuities. With these, you can withdraw your own contributions without penalty, but you could still face this tax penalty for any earnings withdrawn before 59½.

There are some exceptions to this penalty. For example, there are exceptions if you withdraw money for expenses related to becoming disabled or if you are a qualified first-time homebuyer. Check out the IRS list of exceptions for more details.

Third, these accounts have required minimum distributions (RMDs). For traditional IRAs and individual retirement annuities, you must withdraw a certain amount each year beginning the year you turn 72. The amount you must withdraw is calculated based on your life expectancy — see the IRS table Appendix A here for more information.

RMDs don’t apply to your Roth IRAs or individual retirement annuity, although mandatory distributions will apply to your beneficiaries after your death.

Other Guidelines to Consider

There are a number of other guidelines that apply to individual retirement annuities. These include:

• Many individual retirement annuities have a minimum deposit requirement.
• Many individual retirement annuities also have annual fees that apply. Usually, fixed annuities have much lower fees than variable annuities.
• You make contributions over time, and you can change the payout amounts as you like (as long as you stay under the contribution limits).
• An individual retirement annuity has to be issued in the name of the annuity owner. They cannot transfer the annuity or any portion of it to anyone; if you die before the annuity contract expires, only your surviving spouse or beneficiaries can receive your payments.

Is an Individual Retirement Annuity Right for You?

If you’re trying to grow your retirement savings, both individual retirement annuities and IRAs could be useful for you.

IRAs and individual retirement annuities offer significant tax benefits for retirement savings. They have similar rules for contributions and withdrawals and can be structured in “traditional” or “Roth” versions.

There are some major differences. IRAs are more flexible in that they can hold many types of investments, including higher-risk investments like stocks, but IRAs are unable to guarantee you a retirement income. These are better for individuals who want to put their money in a diverse investment portfolio and are comfortable with higher risk. Often, people are more open to this greater risk when they are younger.

Individual retirement annuities can hold either low-risk fixed annuities or higher-risk variable annuities. Both of these can guarantee you a retirement income to supplement a pension, social security, or other income sources. Fixed annuities, in particular, are better for people who want a very low-risk way to steadily grow their nest egg. This makes them especially useful for people with lower risk tolerance and people who are closer to retirement.

If you’re not sure what the best option for your retirement savings is, you might benefit from talking to a financial advisor. They can help you figure out what your goals are and find the product that would work best for you.

If you’re considering an annuity, check out Canvas Annuity’s fixed annuity products, they specialize in annuities that are simple and safe. They offer a fixed minimum interest crediting rate over the term of the annuity, so you can have peace of mind that your savings will steadily grow. Then, when you need it, you can convert it into a steady stream of income.

Apply online today.