Choosing what is the best way to provide guaranteed retirement income can be difficult, to say the least. An annuity is an insurance vehicle that offers a fixed stream of payments. On the contrary, an IRA is a retirement plan that allows the investor to compound long-term savings for one’s retirement years. In this article, 5 experts discuss which is better at generating safe retirement income, an annuity or an IRA.
It’s Not Either An IRA Or An Annuity, It Can Be Both Combined
“So here is the reality…you generally don’t have the question of which is better, an IRA or an annuity. This is because an annuity is simply another type of investment vehicle into which one can invest money. It is an insurance contract with some underlying expenses that are similar to what one might find in a life insurance contract…mortality & expense charge among them, and usually costs associated with the underlying investments. Annuities can come with different guarantees related to the death benefit and the distribution options, and, depending on the type of contract purchased, can provide various distribution options.
You can own an annuity and have it held inside an IRA [a tax-qualified account], just like you can own a mutual fund, ETF or individual stock position inside an IRA. You can also have an annuity held not in an IRA [non-tax qualified account]. Depending on the type of annuity purchased the underlying investments can vary, ranging from fixed instruments invested in the underlying general account of the insurance company issuing the annuity, to being tied to an index like the S&P 500, or even tied to the stock market, as in the case of a variable annuity where the underlying investments are variable sub-accounts that mirror mutual funds.
Annuities are tax-deferred investment vehicles, as are IRAs, so owning a tax-deferred annuity inside a tax-sheltered IRA can be redundant. That said, there can be legitimate reasons why one might consider investing some of their IRA assets in an annuity. They may want to have the promise of some of the guarantees that are provided inside an annuity…for the additional fees involved.
So the short answer to your question is it’s not either an IRA or an annuity, it can be both combined.”
Jimmy Masters, AIF(r) CRPS(r), Wells Fargo Advisors
An Immediate Annuity Should Provide A Higher Return Than The IRA
“Since the yield of the IRA depends on what types of investments are in the IRA, we can assume the retiree is using bonds to generate conservative income. In this instance, an immediate annuity should provide a higher return than the IRA (bonds) because annuities offer “mortality credits”. An insurance company pools a lot of people’s money. The law of large numbers gives the insurance company a good idea about life expectancies of the group. Since some people will pass away earlier than others, this leftover money is used to offer a higher payout in the annuity.
In addition, with interest rates remaining low, bonds look like an unattractive way to generate income.”
Jake Norton, Financial Planner, Stewardship Financial
An IRA That Includes Both An Annuity And Managed Assets May Represent The Optimal Solution
“As a 41 year veteran in the financial services industry who has witnessed numerous market swings, I believe your question should be broadened. It is not an either or question but, perhaps the answer includes both.
Annuities that pay income come in several shapes and forms. A SPIA is a single premium immediate annuity that pays out a fixed income over a fixed period of time and is NOT impacted by economic factors such as interest rate fluctuations and stock market volatility. A variation of a SPIA is a deferred income annuity that does what the name implies, defer income for a certain time period and then turns on the income spigot. This vehicle would be appropriate for a retiree who has an immediate need for income and is willing to carve out a portion of the IRA to generate immediate income. For a future retiree who has a 10 year or more horizon before requiring income, there are various variable annuities or equity-indexed annuities that will increase the so-called base benefit over a 10-12 year period and then generate a level of guaranteed income for life. In effect, it is a type of replacement for the defined benefit pension plan. In either scenario, the annuity should serve as a piece of the retirement asset puzzle but not be viewed as a panacea. While the SPIA is generating income, a managed portfolio of mutual funds, ETFs, etc. can be managed and maintained and not subject to substantial depletion in the event that income is withdrawn during a time period when the portfolio is experiencing a significant decline. By eliminating withdrawals during these time periods, the sustainability of such a portfolio is significantly enhanced.
In summary for those clients who want some degree of income guarantees as well as growth, an IRA that includes both an annuity and managed assets may represent the optimal solution.”
Cliff Caplan, CFP(r), AIF(r), Neponset Valley Financial Partners
Perhaps The Safest Retirement Income Vehicle Is An IRA Annuity
“’Safe’ by definition means protected from or not exposed to danger or risk. If safety is your primary factor and you’re deciding between an IRA and an annuity for your retirement income, the annuity is the better choice.
From a financial planning perspective, annuities can serve three purposes – Tax Deferral, Guaranteed Income and access to some unique investment option. There are annuities that offer one of those benefits. There are annuities that offer two of those benefits. There are annuities that actually offer all three of those benefits. The guaranteed income benefits offered by annuities is the “why” behind annuities being the safer retirement income vehicle.
An individual retirement account (IRA) can be opened at nearly any investment and banking financial institution. You are not going to find an investment firm that guarantees the returns for their investments. You could find a bank that “guarantees” it’s CD rates and then you could also argue that the FDIC insurance adds guarantees. However, if you compare the income and guarantees offered by most annuities to that of a bank CD, the annuity wins in the vast majority of cases.
Now let’s clear up a few details that I believe most investors misunderstand. An IRA can be an annuity. You can start from scratch and open an IRA annuity. OR… You can take an existing IRA and buy an annuity with it. An annuity is essentially an investment with certain tax benefits and possible unique characteristics (such as guaranteed income benefits). An IRA is a type of account. It’s not an Investment. With that understanding, perhaps the safest retirement income vehicle is an IRA annuity.”
Ryan M. Smith, CFP®, Partner & Financial Advisor, Paragon Financial Services
Which One Is Better? That Is Up To You
“Today’s younger generations—Millennials and Generation X—see the problems their parents and grandparents have making ends meet in retirement—and they don’t have much faith that Social Security will be there for them when it’s time for them to stop working.
Across the country, a large portion of working-age adults haven’t saved nearly enough to retire, such that half of them risk being unable to maintain their pre-retirement standard of living once they stop working, according to the Center for Retirement Research at Boston College.
The steady shift away from defined-benefit plans (such as pensions) to defined-contribution plans (such as 401(k) plans), along with rising inflation and stagnant earnings, is squeezing the families who need help most. This cosmic shift in how retirement benefits are accumulated means that the burden has now shifted from the employer to the employee. It has turned 100 million unqualified Americans into pension/money managers. We all know too well that even professional money managers can be poor at their jobs. How is a Teacher, Plumber or IT Manager suppose to manage their own retirement savings? The answer is that the vast majority can’t.
What matters is how much of your earnings you will be able to replace in retirement, with Social Security and/or savings. This brings us to the main topic of the article. What is the best way to create “safe” retirement income? Is it an IRA or an Annuity? As an Economist, the key word here is “safe”. To me safe means safe, and that means knowledge that your check will be there each and every month for the remainder of your life. This is regardless of what is happening in Washington D.C. or Wall Street. With that said, the choice is an easy one. An annuity can provide you with that safe and secure check each and every month. (Please note that all annuities are offered only by Insurance companies. The security of your check is tied directly to the financial security of the insurance company who issued it. Be sure to only use a highly rated Insurance company).
So, now that I explained what you are getting with an Annuity, I need to address what you are giving up so that you can make an educated decision. When it comes to investments, every time you get something you give something up. In this case, you are getting a secure monthly check you cannot outlive. At what cost? The cost to you is mainly two-fold. First, you are giving up access to your principle. This means once you annuitize (turn your annuity into a monthly check) you no longer have any access to your principle. If you need a lump sum of money for an emergency, or for any reason at all, the Insurance will not be able to send it to you. Secondly, the safe and secure check is going to be a fixed amount for the remainder of your life. There will be no cost of living adjustments. You will truly be on a fixed income.
So, which one is better? That is up to you. Now that you know what you are getting and what you are giving up you will be better equipped to make the decision that is right for you.
Mark Anthony Grimaldi, Economist, Author of RetireSMART!, Grimaldi Portfolio Solutions, Inc, Sector Rotation Fund (NAVFX)
Annuities and IRAs are both popular vehicles to generate retirement income. If you are interested in IRAs and annuities, take into account what the experts in this article have touched upon, consult a financial professional, and always do your due diligence before investing.