When you're young and just starting out in the financial world, retirement may be the last thing on your mind. But the years will go by faster than you think, and when you’re ready to clean out your office and spend your silver years traveling the world with your significant other, you’ll need to have some source of income. Annuities and individual retirement arrangements, also called individual retirement accounts or simply IRAs, are two retirement savings options. Learning how each functions and the differences between them will help you determine which is best for you.
When you invest in an annuity, you provide a large sum of money to an insurance company, directly or through a broker. Your money is then invested in various securities, including stocks and mutual funds, until you’re ready to retire. The insurance company will then start paying you the money you've made in your annuity, providing you with a new source of steady income. You can choose either a lump sum payout or periodic payments.
With an IRA, you invest a certain amount of money for retirement savings in an account set up through your employer, a banking institution or an investment firm. IRAs are similar to annuities in that the money is dispersed into different investment options to generate a return. Once you’re ready to retire and take that European excursion or Mediterranean cruise, you’ll have a healthy savings waiting for you. The most common types of IRAs are traditional and Roth IRAs.
The biggest difference between annuities and IRAs is the taxes associated with each. With an annuity, taxes are deferred while your money is growing. The drawback is that once you start receiving payments, an income tax will be applied. If you plan to keep moving up the tax bracket ladder, the retirement income tax may prove to be an even bigger drawback.
Taxes vary on IRAs. You can use your contribution as a tax deduction when you invest in a traditional IRA. A Roth IRA doesn’t allow you to deduct your contributions, but your earnings and distributions will stay tax-free as long as your meet the IRS income restrictions.
When it comes to weighing the costs associated with IRAs and annuities, IRAs tend to be a better deal. Annuities are processed and executed by insurance companies, and commissions, broker fees and transaction fees may cut into your return. In addition, you may have to pay additional transfer fees if you decide to reallocate your money to different types of securities within the annuity. IRAs, on the other hand, are arranged through your employer, and the costs are reduced as part of a benefits package. Regardless of which type of investment you're considering, read the fine print and make sure you know exactly what you’re paying for.
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