Americans have up to $2 trillion invested in retirement annuities and $5.7 trillion in 401(k) plans. Both types of retirement plans are popular, but which is the better retirement choice?
When you consider an annuity vs. a 401(k) plan, you’re comparing apples and oranges: The two types of plans are truly that different.
What is a 401(k)?
A 401(k) is an employer-sponsored retirement plan. The employer determines the range of investment options within the 401(k), which can include annuities. The employee chooses the investment opportunities and how much money to contribute to the 401(k) each pay period.
What is an annuity?
An annuity is a form of life insurance. You make either a lump sum payment or a series of payments to the policy. Upon your retirement, the annuity pays a set amount of money to you each month.
Such disbursements may be paid either for a set period or until the policyholder’s death. In the latter case, the longer you live, the more you benefit from the policy.
How to fund these plans
A 401(k) plan is funded by contributing funds from your paycheck. Contributions to the plan are made before taxes, and funds accrue tax-free until withdrawn at retirement. Your employer may also opt to match your contributions up to a certain level.
Annuities are usually purchased with after-tax money, most often by making regular policy payments. It is also possible to fund an annuity by purchasing it with 401(k) money after retirement.
Pros and cons of annuities
The great advantage of an annuity is its stability: Your monthly disbursements after retirement will not change over time and are guaranteed if you choose a fixed annuity.
Variable annuities offer higher returns but greater risk, while indexed annuities offer a guaranteed minimum payout, with a portion of your disbursement tied to investment performance.
On the downside, the annuity market is extremely complicated, and plans vary widely in terms of fees. Bear in mind that while the balance of an annuity is protected from taxes, you will have to pay income tax on disbursements.
What happens with the money after you die?
Choosing between an annuity and a 401(k) plan also affects your legacy. Your heirs will inherit your 401(k) savings as part of your taxable estate.
Annuities typically end with the policyholder’s death, and any money left in the policy is lost. Some annuities include death benefits like regular life insurance, which can be an option if inheritance is a concern for you.
The bottom line
Do you want the option of investing and growing your savings in retirement? If so, a 401(k) is probably your better choice. If you want the security of regular payments in retirement, an annuity may be right for you.
Annuities and 401(k) plans are only two out of many retirement options. Explore the different types of retirement plans, and discover which should be part of your retirement portfolio.