What Is the Difference Between an Annuity & a 401(k) Plan?

Annuities and 401(k) plans are tools to help you save for retirement. These investment vehicles provide tax benefits that can help you reach your goals and prepare for your golden years. Before you decide where to invest your money, compare the features of annuity and 401(k) plans to determine which best meets your needs.

Management and Access

While a 401(k) plan must be sponsored by your employer, annuities are managed by insurance agencies. To invest in a 401(k), you must work for an employer who offers this type of plan. Access to this type of account is not available for those who do not work for the company. An annuity, on the other hand, is open to anyone. Regardless of where you work or what type of benefits your company offers, you have the option to invest in an annuity.

Retirement Payout

Annuities and 401(k) plans differ significantly in the way they pay out once you retire. With a 401(k), you can access your money and use it as you see fit, withdrawing any amount you wish at anytime once you reach minimum retirement age. Depending on what type of annuity you invest in, you may receive your money in a lump sum as soon as you retire, or in the form of monthly, quarterly or annual payments. Some annuities pay out over a specific period, like 10 years, while others offered guaranteed income for your lifetime.

Taxes

A 401(k) allows you to save pre-tax dollars to maximize your savings. When you retire and begin to withdraw money, you must pay income taxes on the money. With an annuity, you invest after-tax dollars. The gains you earn on your investment are then taxed as income rather than capital gains, which can save money.

Borrowing From Your Retirement Account

Both 401(k) plans and annuities are subject to high penalties and fees from the Internal Revenue Service if you withdraw money from the account before you reach retirement age. In some instances, you may be allowed to borrow money from your 401(k) and pay it back without paying a penalty. Annuities do not allow for these types of loans, and you will have to pay surrender fees on top of IRS fees if you choose to withdraw money early.

Contribution Limits

One of the biggest advantages to an annuity is that there is no limit to how much you can contribute to your account each year. As of 2012, 401(k) accounts have a maximum annual contribution of $17,000 per year, or $22,500 for those older than 50. If you want to save as much as possible, an annuity allows you to maximize your retirement savings.