Retirees: Here’s How To Know Whether To Tap Your IRA or Start Annuity Income First
Written by
Laura Bogart
Edited by
Kristen Mae
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Over the past several decades, you’ve been saving for retirement with one clear goal — to ensure your golden years are financially stable. Now that the countdown to your last day on the clock is ticking down, you’re faced with a major decision: How will you convert your savings into a reliable stream of income?
For some retirees, the answer involves taking systematic withdrawals directly from their IRA. Others find security in purchasing an annuity that provides guaranteed payments for life. Both approaches have their upsides and potential pitfalls — and understanding the trade-offs is essential before you choose a strategy.
GOBankingRates connected with Steven Conners, founder and president of Conners Wealth Management, to learn more about what people approaching retirement should consider when deciding between IRA withdrawals or annuity income as their primary cash-flow source.
Understand How Taxation Works
Conners says that IRAs and annuities are generally taxed in similar ways. Most retirees hold either a traditional IRA funded with pre-tax contributions or a nonqualified annuity funded with after-tax dollars, and both grow tax-deferred.
“Annuities may not have a tax deduction, but they are tax-deferred and are taxed as ordinary income when funds are taken out,” he said. Likewise, withdrawals from a traditional IRA are taxed as ordinary income.
However, one key distinction exists: With a nonqualified annuity, only the earnings portion is taxable; your principal comes back tax-free. With a traditional IRA, the entire withdrawal is taxable.
Weigh the Stability of Annuities and the Flexibility of IRAs
Both annuities and IRAs have core strengths. Conners says one of the biggest virtues of annuities is their stability — something many retirees value.
“With a fixed indexed annuity or fixed annuity, your principal invested is never at risk,” he said. This can be highly appealing to people who want predictable income and protection from market volatility.
On the other hand, Conners points out that IRAs are all about flexibility. An IRA is an account, not an investment, meaning you choose how the money is invested — whether in stocks, bonds, mutual funds or even an annuity.
This flexibility means you can adjust your strategy as markets fluctuate or your situation changes — something you can’t do as easily with funds that have been locked into an annuity contract with a surrender period.
Annuities Can Alleviate Longevity Risk
Like many people leaving the workforce — and a steady paycheck — behind, you might worry about outliving your savings. That concern makes income-oriented annuities especially appealing, Conners says.
“You cannot outlive your income payments with a lifetime income rider,” he said. “Also, it does not mean the money invested cannot grow with the stock market. Over time it may increase in value, although most of my clients have their beneficiaries receiving the funds after their lifetime.”
This guaranteed, pension-like income is the main reason many retirees incorporate annuities into their broader withdrawal strategy.
Factor In Required Minimum Distributions
You probably know that the government requires you to start taking money out of your IRA once you reach age 73 — this is called a required minimum distribution, or RMD. What you might not know is that if you buy an annuity using IRA funds, that annuity is still subject to RMD rules.
But if you buy an annuity with money outside of an IRA — often called a nonqualified annuity — you can breathe easier when it comes to mandatory withdrawals.
“If the annuity is not in the name of an IRA, it can be left untouched as it relates to RMDs,” Conners said. “And your IRA, if you have one that’s separate from an annuity, is where the RMD is taken.”
This distinction matters when you’re deciding which accounts to draw from first in retirement.
Assess the Trade-Offs
Ideally, you’d work with a financial advisor who understands your specific situation to structure a withdrawal plan tailored to your savings, health, risk tolerance and goals. But Conners says there are some core factors you can start assessing now.
“If you want more safety with your investments inside your IRA, then perhaps you ought to look at how an annuity will safeguard your retirement and/or provide a lifetime income,” he said. This can be especially helpful if market downturns would make you anxious about selling investments at a loss.
“If you have your IRA and are thinking about converting it to an annuity inside your IRA, keep in mind that most annuities have a long surrender schedule, so it should be money that you’re willing to leave alone for at least a decade,” he said.
Conners adds that if you’re investing within your IRA, you can still trade whenever you like, though you’re exposing your principal to risk — unlike the safety offered by an annuity.
The Bottom Line
Choosing between IRA withdrawals and annuities is a personal decision based on your financial situation, risk tolerance and what you value most in retirement. Many retirees take a blended approach — keeping some money in an IRA for flexibility and emergencies while using an annuity to cover essential expenses with guaranteed income.
The right mix can help ensure your retirement income is both reliable and adaptable — giving you peace of mind no matter what the markets do.
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