Annuity vs 401k: Similarities & Differences

Annuity vs 401k

Since a comparison is inevitable, given the need for a beneficial retirement plan is critical, we would leave the justification to subjectivism. You get to decide which retirement plan you want to choose. That is where I would suggest you rethink the question – “Which is the best retirement plan, a 401k or annuity?”

It all depends on how you want to scale your finances and plan your retirement. 401k provides a tax-advantaged savings plan for your retirement. Conversely, an annuity is for people who want a guaranteed lifetime income. 

In both cases, you compromise some to win some. With 401k, you can take a tax break when investing or withdrawing. An annuity is like reassuring a salary after retirement with the tax-deferred before you start getting your payment. I am pretty sure you need a deep dive into the nuts and bolts of both of the retirement investment vehicles. So, do not delay, and keep yourself informed by scrolling down. 

Annuity Vs 401k

Most USA-based employees are enrolled in their employer’s 401k plans. They are enjoying tax advantages on most of their retirement savings every year. Annuities, on the other hand, grow in a tax-deferred manner and require payment of tax during withdrawal. 

401k, the most common retirement investment plan in the US, has two different types of tax-deferred options. The traditional 401 k allows tax-deferred savings with tax obligations imposed during withdrawal after the age of 59 ½ years. The same can also happen before the age of 59 ½ if certain conditions are met.

With Roth 401(k)s, there is no upfront tax break or benefits involved. But, the withdrawals are completely tax-free during retirement. Unbelievably so, Roth 401 K takeouts after the age of 59 ½ do not apply any taxes to it. 

An annuity, on the other hand, provides an insured source of regular income through a contract. Investors can expect a regular taxed payout from their investment in the annuity. In short, you just save your money through an annuity investment, and they make payments to you for a specific period. 

Most of the US employees with a 401k plan know what a 401k is. But, currently, many employers have been providing annuity plans to their employees. So, they are becoming more and more aware of this retirement investment vehicle. 

Here is a detailed set of differences and similarities between both annuity and 401k. 

Annuity Vs 401k: Similarities

Both 401k and annuity have many similarities, making both attractive retirement plan options. 

Long-Term Savings Vehicle

If you do not have a lump sum of money you can save for retirement, do not worry. 401k and annuity provide an option to invest in your retirement fund over time with different tax benefits. Your employer may already provide an annuity or 401k investment plan for retirement. 

Tax Deferred Investment

Both traditional 401k and annuity are tax-deferred retirement investment vehicles. Investors can save their pre-tax salary into their 401k investment plan. The money goes in a tax-deferred system with income taxes charged during the withdrawal. A similar system is preset in an annuity where investors can expect a promised taxed payout for a specific period.

What’s more interesting is – that Roth 401 k investments do not also charge tax on payout. However, the investor has to withdraw the money after they turn 59 ½ or older or meet other necessary requirements for an early withdrawal. 

Penalty For Early Withdrawals

Both annuity and 401k early withdrawals have rules for a penalty during withdrawal if the investor is withdrawing before they are 59 ½ years of age. However, there are also exceptions for penalties in annuities and penalties. You can also avoid paying fines by accepting SEPPs. 

Assets Do Not Have To Pass Through Probate

When an investor nominates a beneficiary on an annuity or 401k, those assets are not supposed to go through probate. It is possible to pass it on to a named beneficiary directly. 

Annuity Vs 401k: Differences

Here are some differences between annuity and 401k –

Commission

Employers do not have any scope to earn any compensation when their employees participate in their 401k plans. On the other hand, agents can earn a commission for each of the annuities they sell.

As an investor, you should look out for yourself and see if the agents only want to earn that commission or also to help you out with the annuity.

Employer’s Matching Contribution

One of the substantial differences between an annuity and a 401k is in the employer’s contribution. Employers also contribute to the employee’s 401k plan. However, investors with an annuity choose a third-party insurance provider for an annuity. Hence zeroing down on the chance of the employer’s contribution. But, employees can use the 401k contributions of their previous employers to buy an annuity. 

Limits For Contribution

Employees enrolled in their employer’s 401 K plan have a 401k contribution limit for a particular year. The limit in 2022 was $20,500 and was further raised in 2023 to $22,500. Also, the combined contribution limit for employee and employer contributions is $61,000. However, there is no limit as to how much one can invest in an annuity. 

Insuring Your Income

An annuity is more like insuring your income post-retirement. You can keep contributing to an annuity to receive a taxed payout from a specific period. But, the same does not apply to a 401k investment. Yes, the investment growth here is tax-deferred, but the taxed payout happens once. 

Investors can take out a lump sum without any periodic payout system. Annuity ensures you receive a salary post-retirement. But 401k provides a lump sum of money with a freedom of expenditure.

Choosing Investment

The growth of investment through annuity is gradual and modest, with the investor’s zero control over the underlying investment. But 401k, on the other hand, provides multiple choices for selecting an investment asset.

While there are some index annuities allowing investors to choose investment assets to certain degrees, they fall short in front of the wide array of choices 401k provides. 

Asset Liquidity

Investors can opt for 401k loans if they want to cash out their 401k investments. In this case, there are no penalties involved if the investor repays their loan. 

On the other hand, liquidating an annuity means paying up a surrender charge (much like an early withdrawal penalty for 401ks) along with IRS penalties. It might also make them lose some of their money.

Investment Returns

The gains and losses on 401K investments are uncapped. An investor can both gain and lose to an uncapped limit by investing in 401K. On the contrary, annuity plans pretty much outline the gains and losses. 

Final Words

Every pathway can lead to somewhere unknown. All retirement investment vehicles have their risks and rewards. But, as to which one you choose is subjective to one’s life, situation, income, and current financial state. It also depends on how someone wants to plan their retirement. 

Hopefully, this article will provide you with the information you are seeking. Please let us know your take on both of the retirement plans. Thank you for reading.

Read Also:

• What Happens To Your 401k When You Leave A Job?
• How To Transfer 401k To New Job? Step By Step Guide
• How To Find Old 401k Accounts And What To Do Next?