Annuities in IRAs rarely make sense because you lose the main tax benefit annuities offer

An annuity is a contract where you give an insurance company a lump sum, and they pay you back in installments over time or for life. The appeal of annuities is that they let you defer taxes on the money you earn inside them—you don't pay tax on gains until you withdraw. But an IRA already does that. Putting an annuity inside an IRA means you're paying insurance company fees and accepting their terms to get a tax shelter you already have for free.

The real cost is the fees. Annuities charge surrender charges (penalties if you withdraw early), annual management fees, and commissions to the person who sold it to you. Those fees can run 1 to 3 percent per year, sometimes higher. Inside an IRA, where your money is already tax-deferred, you're paying those fees to get nothing you didn't already have. You could buy a simple index fund in the same IRA and pay 0.03 percent per year instead.

There is one narrow exception: if you want may provide income for life and you're willing to lock up money you won't touch until a specific age, a deferred income annuity (DIA) inside an IRA can make sense. But even then, you should compare the may provide payout to what you'd get from a plain bond ladder or a low-cost target-date fund. Most people don't need the may provide badly enough to justify the cost.

Key Takeaways

  • An IRA already gives you tax-deferred growth, so an annuity inside one duplicates a benefit you already paid nothing for.
  • Annuities charge surrender fees, annual management fees, and sales commissions that typically run 1 to 3 percent per year—costs you avoid by holding mutual funds or ETFs in the same IRA.
  • The only scenario where an annuity inside an IRA might make sense is if you want a may provide monthly payment for life starting at a specific age, and even then you should compare the payout to other options.
  • If you want an annuity for the income may provide, buying it outside an IRA with after-tax money lets you use the tax deferral feature that actually justifies the cost.

How tax deferral works in an IRA versus an annuity

An IRA—whether traditional or Roth—lets your money grow without paying tax on the gains each year. If you buy a stock fund that earns 8 percent annually, you don't owe tax on that 8 percent until you withdraw the money (or never, in a Roth). That's the entire point of the account.

An annuity does the same thing: it defers taxes on earnings until you take money out. But an annuity is a product sold by an insurance company, not an account type. When you put an annuity inside an IRA, you're using the IRA's tax shelter to hold an insurance product that has its own (redundant) tax shelter built in. You're paying for a feature twice.

Outside an IRA, an annuity's tax deferral is valuable. If you buy an annuity with after-tax money, the tax deferral saves you money because you're not paying annual tax on gains. Inside an IRA, that same tax deferral is worthless—you already have it from the account itself.

The fee structure that eats into returns

Annuities come with several layers of cost. A surrender charge is a penalty you pay if you withdraw more than a small amount (usually 10 percent per year) before a set number of years pass—often 5 to 10 years. These charges can be 5 to 10 percent of your withdrawal, though they typically decline each year. If you need your money, you're stuck.

On top of that, annuities charge annual fees for mortality and expense risk (the insurance company's cost to may provide payments), administrative fees, and fees for any riders you add (like a may provide income rider). These typically range from 0.5 to 2 percent per year, sometimes more. You also pay the sales commission, which is often 5 to 7 percent of your initial investment—money that comes out of what you put in.

A simple index fund in the same IRA costs 0.03 to 0.20 percent per year. Over 20 years, the difference between a 1.5 percent annuity fee and a 0.10 percent fund fee compounds significantly. On a $100,000 investment growing at 7 percent annually, that 1.4 percent fee difference costs you roughly $50,000 in lost growth.

When an annuity inside an IRA might make sense

A deferred income annuity (DIA) is the only annuity product that has a legitimate use inside an IRA. With a DIA, you give the insurance company money now, and they promise to pay you a fixed monthly amount starting at a future date—say, age 75 or 80. You know exactly what you'll receive and when.

This can be useful if you want to may provide that part of your retirement income is locked in, regardless of market performance or how long you live. You're trading liquidity and growth potential for certainty. But you should run the numbers: compare the may provide payout to what you'd get from a bond ladder or a target-date fund that becomes more conservative as you age. Often the may provide amount isn't high enough to justify locking up the money.

Even if a DIA appeals to you, consider buying it outside the IRA instead. If you use after-tax money, the tax deferral feature actually saves you money. Inside the IRA, you're still paying the annuity's fees to get a tax benefit you already have.

The better alternative: low-cost funds in your IRA

For most people, the best use of an IRA is holding a diversified mix of low-cost index funds or target-date funds. You get tax deferral at no cost, you can rebalance or withdraw without surrender charges, and your fees stay under 0.20 percent per year.

If you want some money set aside for may provide income later, you can buy a DIA outside the IRA with after-tax dollars. That way, the annuity's tax deferral actually saves you money. The rest of your IRA stays flexible and low-cost.

If you already own an annuity inside an IRA and you're past the surrender charge period, consider moving the money to a low-cost fund. If you're still in the surrender charge period, calculate whether the penalty is worth paying to escape the ongoing fees. Often it is, especially if you have many years left until retirement.

What happens to an annuity in an IRA at withdrawal or death

When you turn 73, you must take required minimum distributions (RMDs) from a traditional IRA. If you own an annuity inside the IRA, the RMD rules still apply—you can't just let the annuity sit and collect payments. You have to withdraw enough from the IRA each year to satisfy the RMD, whether the annuity is paying you or not.

If you die before the annuity starts paying, your beneficiary inherits the IRA and the annuity inside it. They'll owe income tax on withdrawals, just as you would. The annuity's terms don't change—they still apply to your beneficiary. This can create complications if the annuity has a long deferral period or if your beneficiary needs access to the money sooner than the annuity allows.

Frequently Asked Questions

Can I move an annuity out of my IRA if I change my mind?

You can move the money to another IRA investment through a trustee-to-trustee transfer without tax consequences. But if the annuity has a surrender charge, you'll pay a penalty on the amount you move. Check your annuity contract for the surrender charge schedule—it typically declines over time, so waiting a year or two can reduce the cost.

What if the annuity guarantees a specific return?

A may provide return inside an IRA is still redundant—the IRA already shelters you from taxes on that return. Outside an IRA, a may provide return would be valuable because you'd avoid annual taxes on the gains. Inside, you're paying fees for a may provide that doesn't save you money compared to a low-cost bond fund.

Is a variable annuity better than a fixed annuity in an IRA?

No. Variable annuities (where your return depends on market performance) charge even higher fees than fixed annuities—often 2 to 3 percent per year—and still offer no tax advantage inside an IRA. A simple stock index fund does the same job for a fraction of the cost.

What if my employer offers an annuity option in my 401(k)?

The same logic applies: the 401(k) already defers taxes, so the annuity's tax deferral is wasted. However, some employer plans negotiate lower annuity fees than you'd pay buying one on your own. Compare the fee schedule to a low-cost fund option in the same plan before deciding.

Can I use an annuity to avoid RMDs?

No. RMDs apply to all money in a traditional IRA, including annuities. You cannot use an annuity to delay or reduce your required withdrawals. The only exception is a may have access to longevity annuity contract (QLAC), which has special rules allowing you to exclude up to $165,000 (as of 2024) from RMD calculations, but QLACs have their own restrictions and costs.