Annuities and retirement plans come in various forms, and they have some stark differences. Among them: Annuities are issued by life insurance firms, but retirement plans, such as 401(k) plans, are administered by employers. Certain types of annuities promise income after retirement, but income from a 401(k) depends on performance in the financial markets. However, both types of investment help save for retirement. They share some advantages and disadvantages, as well.
Markets & Economy
Retirement plan investors often have their entire savings tied up in the financial markets. This places retirement income at risk, especially for people who stop working during a market downturn and have little time to recoup financial losses. Throughout the financial crisis of 2008, 401(k) investors who were planning to retire lost trillions of dollars in the financial markets. Annuity holders are especially vulnerable to changes in economic conditions. Annuity payments are not adjusted for inflation, which means a drop in buying power for people who retire during a high-inflation period.
There are pros and cons associated with the taxation of annuities and retirement plans. On the plus side, investors can make contributions up to a certain threshold and experience investment gains on a tax-deferred basis. However, when it's time to begin making withdrawals from that retirement account, taxes kick in. Annuity policyholders and retirement plan contributors alike are subject to regular income tax on their investment gains rather than the lesser capital gains tax rate.
People who withdraw money from their retirement account before retirement age are at similar disadvantages, whether they are invested in an annuity or a retirement plan. The penalty for early withdrawals from an annuity or from a qualified retirement account is 10 percent for people who are more than six months away from turning 60.
The income from an annuity or a retirement plan is a definite pro. Certain annuities in particular promise to pay policyholders a set amount in retirement regardless of stock market performance. That guarantee depends on the financial health of the insurance company issuing the annuity. In an attempt to lessen their dependence on the unpredictable financial markets, some 401(k) plans offer investors the security of an annuity option.
Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.