If you’re getting close to retirement, are you sure that you’ll have enough money to live the kind of life you want? The good news is that there are many options to help you reach your retirement goals — but picking the right one can be challenging.

When considering investment vehicles, you may have thought about the differences between an annuity vs. a traditional 401(k). Both options have similarities but some important differences that could impact your retirement.

This guide will teach you everything you need to know about the pros, cons, and differences of annuities and traditional 401(k)s.

Annuity vs. Traditional 401(k): The Basics

Annuity vs. 401(k): A Side-By-Side Comparison

Annuities and 401(k)s are financial products designed to provide you with income in retirement. Traditional 401(k)s and annuities are both tax-deferred products, so you won’t pay taxes on the money you put into them until you make a withdrawal. Roth 401(k)s are different because you fund them with taxed income.

Other similarities include:

  • Long-term savings. Both options enable you to grow your savings over time.
  • Penalties for withdrawing money early. Because these products provide you with tax-deferred benefits, you can be penalized for withdrawing funds before the age of 59.5.
  • Avoiding probate. By naming a beneficiary, the assets in an annuity or 401(k) can be transferred right to them instead of having to go through the probate process.
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How soon are you retiring?

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What is your goal for purchasing an annuity?

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What’s the Difference Between an Annuity and a 401(k)?

The Differences Between Annuities and 401(k)s

Now that we’ve seen the similarities between annuities and 401(k)s, let’s look at what makes them different.

What Is a 401(k)?

401(k)s are retirement plans usually offered through your employer. With a traditional 401(k), you contribute a set percentage of your pre-tax income to a fund that is specifically designed to grow at a steady rate over time.

More information about 401(k)s:

  • There are limits on contributions. The government sets yearly limits on how much money a person can contribute to their 401(k).
  • Minimal fees for well-governed plans. Your employer almost always pays for the fees for a 401(k).
  • 401(k)s are made up of different financial products. These can include stocks, bonds, mutual funds, and money market funds.
  • Some employers will contribute to your 401(k). As an employment benefit, an employer can match a portion of your 401(k)contribution. Over time, this can help you build a much larger account than you’d be able to grow on your own.
  • There are limited investment options. These plans have set allocations that you can’t change.
  • You could see uncapped returns (and losses). Because a 401(k) is funded by investments, there are no limits on the amount you can gain or lose. While these plans are designed to grow at a predictable rate, there are no guarantees. Inflation can lessen the benefits of your 401(k).

What Is an Annuity?

An annuity is a financial product offered by an insurance company. You can fund an annuity all at once with a lump sum or you can add to it over time to grow its value before you start taking money out of it. While some employers provide options for annuities in retirement plans, they’re usually purchased directly from an insurance company.

According to Lou Cannataro, a founder and partner at Cannataro Family Capital Partners “a good-performing annuity is another great tool to have in your financial toolbox if done properly.”

  • Annuities provide guaranteed lifetime income. Many annuities will provide you with payments for the rest of your life. Some annuities will continue to pay out to your beneficiaries after you pass away. With an annuity, you don’t have to worry about losses in the market because your income is guaranteed by the contract you signed with the provider.
  • Annuities are usually after-tax savings vehicles. Funding an annuity with taxed income means that you won’t pay tax on the principal when you start taking payments. Instead, you only pay taxes on any gains during annuitization.
  • Employers might not contribute to annuities. This could limit the overall amount of money you have to retire.
  • There are no limits on contributions. Unlike 401(k)s, the government doesn’t cap contributions to non-qualified annuities. Contributing to a non-qualified annuity if you’ve met the cap on your 401(k) can help you continue to save for retirement and provide additional income later.
  • You could pay more fees with an annuity. Depending on the type of annuity you choose, as well as any riders, there are several fees you may need to pay each year.

Different Types of Annuities

Annuities are not one-size-fits-all. Below, you’ll be able to learn more about some of the most common types of annuities, along with their benefits and some common reasons to choose them.

Immediate Annuities
An immediate annuity is paid for with a lump sum up front. It guarantees monthly payouts and is a way to provide you with more money for retirement. You can start receiving payments immediately upon retirement.
Deferred Annuities
A deferred annuity provides you with tax-deferred growth. You receive guaranteed lifelong income starting on a set date. Deferred annuities give you more money since it has more time to accumulate.

Beyond these high-level categorizations, an annuity can be structured to payout as follows:

Lifetime Annuities
With a lifetime annuity, you will receive income for the rest of your life. The amount you receive is based on the specific annuity but is affected by your age and health.
Fixed-Period Annuities
Unlike a lifetime annuity, fixed-period annuities only pay out during a set period. Your health and age don’t affect how much you receive with a fixed-period annuity.

Annuities Based on Growth Potential

Fixed annuities
The most stable and predictable. Interest rates stay the same within the time period stipulated in the contract. Fixed annuities can be impacted by inflation. If inflation rises, your fixed payments will be worth less.
Multi-year guaranteed annuities (MYGAs)
MYGAs are annuities with fixed interest rates that last for a specific time period. A MYGA is a good option for people who are close to retirement because it provides an opportunity for deferring taxes but with a guaranteed ROI.
Variable annuities
Function in a similar fashion to mutual funds. Your payments depend on the performance of the stocks, bonds, or other types of accounts that fund that particular annuity. These annuities can lead to higher returns than fixed annuities, but they expose you to downside risk and can result in loss of principal.
Fixed index annuities
Provide payments based on a market index. While payments can fluctuate, you are protected from losing your principal investment. This protection comes with limits on gains as well.

There are other types of annuities that feature a variety of options and riders, including:

  • Annuities designed to provide payments for long-term care
  • Life-only annuities that don’t pass on payments to beneficiaries
  • Joint annuities that continue paying as long as at least one owner of the annuity is alive
  • Riders that provide money for long-term care

Should You Invest in a 401(k) or an Annuity?

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Your specific circumstances will determine which investment options are best for you.

Speak with a qualified financial advisor before making decisions about investments and retirement. They can provide you with information and options that you might not otherwise be able to find.

It’s important to know that you can invest in both an annuity and a 401(k). For many people, a combination of these products might be the best way to ensure the standard of living you want. With an annuity that is designed to provide you with specific benefits like paying for long-term care, you can ensure that your 401(k) is available to pay other costs or to pass it on to your beneficiaries.

Having both an annuity and a 401(k) also gives you more control over your tax liability each year.

Should You Buy an Annuity With Your 401(k)?

You may be able to use some of the money from your 401(k) to invest in an annuity. This is an option if you don’t have extra money to invest. If you are nearing retirement age and you aren’t certain that you have enough time to accumulate and annuitize an annuity, your 401(k) could be the answer.

Buying an annuity from a 401(k) can be a good option because:

  • It could provide you with a better payout.
  • If you’re a woman, buying an annuity within a 401(k) means a lower price (since women live, on average, longer than men).
  • It may be the only way you can fund an annuity. Without a large lump sum of savings, the money you’ve accrued in a 401(k) can provide you with the capital to get an annuity.

But there are some potential drawbacks of going from a 401(k) to an annuity, including:

  • Lower growth. Because it takes years for a deferred annuity to grow, you could miss out on other opportunities. Other investments, like stocks or ETFs, could provide better growth faster.
  • Limited options for changing your mind. You may have to pay surrender charges if you need to pull money out while an annuity is growing. And you can almost never get a refund on an annuity after you start taking payments.
  • Not breaking even. It’s possible to pass away before the principal has been paid out. Depending on the kind of annuity, your beneficiaries may not receive payments.

It’s vital that you talk to a financial advisor before removing money from your retirement funds. They can explain any pros and cons, as well as let you know what kind of penalties you may face if you withdraw money early.

A financial advisor can help you find ways to fund an annuity while providing you with other guidance about how to prepare for retirement.

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Preparing for Retirement

There are many options available to help you fund your retirement, but that doesn’t mean it will always be easy. Both 401(k)s and annuities offer you a way to save and grow money, but they each have pros and cons to consider before you make changes to your investments. Check out our retirement timeline below to learn more about saving for retirement.

If you think that an annuity might be the right choice for you, contact us today for a free quote.

How to Set Retirement Goals Over Five Years Infographic
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Please seek the advice of a qualified professional before making financial decisions.
Last Modified: October 30, 2023
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