What Is the Difference Between Annuities and 401(k) Plans?

Annuities and 401(k) plans are both programs to help people save money for retirement. Both can defer taxes, so contributions now are deducted from income for tax purposes but withdrawals are taxed after retirement, when an individual's tax rate should be lower. Either also can be funded with money that's already been taxed, so there is no tax on withdrawals.

Annuity

An annuity is a program through an insurance company to accumulate money and earn interest or dividends with funds to be withdrawn as desired or on some specific pre-arranged schedule. An annuity also includes a death benefit like a life insurance policy. You can invest in some annuities through a 401(k) or individual retirement arrangement or buy individual accounts.

401(k) Plan

A 401(k) is an employer-sponsored retirement program usually with some contribution from the employer. Both employee and employer contributions earn interest. Similar programs for educational and nonprofit organization employees are called 401(b) plans, and those for state and municipal employees are called 457s. They are "defined contribution" programs, meaning a set amount is put in regularly.

No Contribution Limit

A major advantage with an annuity is that there is no limit on contributions. There also are no specific constraints on withdrawals. An investor does not have to wait until retirement. Money can be withdrawn piecemeal as needed, as a lump sum or in regular payments as a supplement to other retirement income. Money that was taxed before it was contributed is tax-free.

401(k) Limits

A traditional 401(k) has a limit on tax-deferred contributions. The plan itself may limit contributions and employers may only match a certain amount, but the Internal Revenue Service limit is $17,000 for 2012, with a cost of living adjustment due in future years. That limit is increased by $5,500 for those 50 years and older in 2012, with cost of living adjustments beyond that.

Employer Ties

A 401(k) program is tied to an employer, while an annuity is not. In some cases, a 401(k) can be left in place if an employee changes jobs, and in other cases it can either be transferred to another employer's 401(k) program or rolled over into an individual retirement arrangement. An annuity is contract between an individual and an insurance company, not tied to any work.

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