Traditional IRA Vs. Variable Annuities

IRAs and variable annuities are ways to build up a retirement nest egg.
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If you want to save money for retirement, variable annuities and traditional individual retirement arrangements are tax-advantaged options. Both defer taxes on earnings until you take your money out. However, beyond the tax-deferral, IRAs and variable annuities are very different in structure, cost and how your money ultimately gets taxed. Which one is better for you is a personal financial choice based on your financial objectives, tax situation, age and other factors.


If you want a broad range of investment options, an IRA may be a better choice for you than a variable annuity. IRAs can invest in almost anything, from stocks and bonds to mutual funds and certificates of deposit. Only a few types of investments -- including insurance and collectibles -- cannot be purchased in an IRA. Variable annuities offer only a fairly limited range of mutual fund-like "subaccounts." Typically, the sub-accounts cover broad investment choices -- such as growth accounts, consisting mainly of stocks, or income accounts, largely made up of bonds. However, since variable annuities are issued by insurance companies, you'll usually only get to choose from sub-accounts managed by the insurance company itself or affiliated mutual fund companies.


Costs within a variable annuity are typically much higher than in an IRA. Many IRAs are fee-free, with your only costs being the commissions on products you buy and sell within the account. Variable annuities charge annual fees that often top 2 percent annually and can reach as high as 4 percent per year. If you decide to sell your annuity within the first several years, you'll face a surrender charge of as much as 7 percent. If you decide you no longer want an IRA, you'll have to sell the investments you have in the account, but it usually won't cost you anything to close the account.


You can often get a tax deduction for money you put into a traditional IRA. This isn't true if you or your spouse are covered by an employer retirement plan, such as a 401(k), and you have an income exceeding the IRS limit. However, many taxpayers can deduct the full amount of their IRA contributions. A variable annuity is funded with after-tax money. This means you won't get a tax deduction on any money you put in.


You'll face the tax man when you take money out of either a traditional IRA or a variable annuity. The sting is likely to be greater with an IRA, however. Unless you made any after-tax contributions to your IRA, which is pretty rare, you'll owe income tax on anything you take out of the account. With a variable annuity, your contributions have already been taxed, so you won't pay tax again. However, you will owe tax on your earnings. A formula known as the "exclusion ratio" determines what percentage of your variable annuity withdrawals are taxable. For both annuities and IRAs, you'll owe an additional 10 percent in penalty tax if you're under age 59 1/2 when you take money out.

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