Difference Between Annuity and 401k
Annuity is a life-insurance policy which is setup to work as the investment plan where a contract is made between a participant and an insurance company in which participant give money to insurance company and in return insurance company make payments as per the terms and condition whereas 401k is a popular tax-deferred retirement savings plan which is sponsored by employers in which employees are allowed to divert their salary portion by making the defined contribution.
An annuity is an insurance product while 401k is a retirement product or plan offered by the employer. In this article, we look at the differences between them –
- An annuity is an insurance product wherein installments are made on a periodic basis. An annuity can be considered as a contract between the investor and a party where the investor pays a lump sum amount to the organization and receives the installment once age has reached.
An annuity gives steady income to the investor after he/she reaches the retirement age. Annuities also provide death benefits and give the beneficiaries a pre-decided amount in case there is a sudden death of the investor before the end of tenure. It is possible for an investor to own annuities jointly and they can be brought with money in the taxable account. - 401k plan types are one of the most popular retirement plans in the US. 401k is planned by the employer but the contribution is made by the employee. 401k is saving for retirement. The employee deducts a particulate amount from the salary of the employee every month and uses this as an investment towards the fund which the employee will get after retirement.
The deduction is tax-deferred. The maximum amount which can be contributed is $18,500 per annum and the amount of tax is deferred until payments are received till retirement.
Annuity vs 401k Infographics
Let’s see the top differences between annuity vs 401k.
Key Differences
- An annuity is not tax-deductible while 401k offers a double tax benefit. Taxes need not be paid until the money is taken out for retirement. Due to the monthly contributions, the amount of taxes paid is also reduced
- The annuity withdrawals are not tax deductible but they do allow for IT deferral. When money is taken out from the account the entire amount is taxable.
- The annuity does not have a limit on contributions to make. There is a limit to the contributions that can be made. As of 2019, only $19,000 can be invested. Once the investor touches 50 the limit is increased to $25,000 a year
- An annuity can be jointly owned and can be purchased by anyone who is an adult. 401k cannot be jointly owned. It cannot be purchased and is provided only by the employer
- Fees for an annuity are higher. Extra fees or any kind of commission does not have to be paid when money needs to be pulled out of 401k.
- Following are the main types of an annuity –
- Fixed Annuities – These types of annuities are not affected by changes in interest rates or market fluctuations and are thus the safest types of annuities. Types of fixed annuities are Immediate Annuity and Deferred Annuity. In an immediate annuity, the investor receives payments as soon as he makes the first investment. In a deferred annuity, the money is accumulated for a predetermined period before the payments begin
- Variable Annuities – These annuities as the name suggests are variable in nature and give an opportunity for investors to generate a high rate of returns by investing in equity or bonds. Income will depend on the performance of these assets. This is meant for investors who are ready to take the risks
- There are no particular types of 401k accounts.
Annuity vs 401k Comparative Table
| Basis | Annuity | 401k | ||
| Purpose | An annuity is an Insurance Product | 401k is a retirement product or plan offered by the employer | ||
| Tax | An annuity is not tax-deductible | It offers a double tax benefit. Taxes need not be paid until the money is taken out for retirement. Due to the monthly contributions, the amount of taxes paid is also reduced | ||
| Withdrawals | The annuity withdrawals are not tax deductible but they do allow for IT deferral | When money is taken out from the account the entire amount is taxable | ||
| Insurance | Annuities offer life insurance coverage. (A certain fee may have to be paid) | 401k is a retirement plan offered by the employer | ||
| Contributions | The annuity does not have a limit on contributions to make | There is a limit to the contributions that can be made. As of 2019, only $19,000 can be invested. Once the investor touches 50 the limit is increased to $25,000 a year | ||
| Benefits | Acts as a supplement fund and has no limit on contribution. It is best for individuals nearing retirement with beneficiaries | Useful for retirement and is tax beneficial | ||
| Best Used for | Best suited for individuals who need fixed payments in retirement | Best used as a retirement fund. | ||
| Types | Fixed and variable annuity are the two main types of Annuity | There are no types of 401k accounts. | ||
| Ownership | An annuity can be jointly owned and can be purchased by anyone who is an adult | 401k cannot be jointly owned. It cannot be purchased and is provided only by the employer | ||
| Fees | Fees for an annuity are higher | Extra fees or any kind of commission does not have to be paid when money needs to be pulled out of 401k | ||
| Loans | Annuities do not offer loans. When money is taken out from the account it will only be withdrawals | Some 401k plan offers loans on the amount that is in the account. An amount of $50,000 can be borrowed from the account |
Conclusion
Both Annuity and 401k provides sound retirement plans if managed properly. The annuity has a large number of options while there are no options in 401k accounts. The main difference between these two schemes lies in the amount of contribution limit. Contributions in 401k are restricted with limited funds while the annuity is not affected by any such limitations.
Both these products provide the chance to increase and grow your investment on a tax-deferred basis. An important point to note is that these investments are not mutually exclusive and an investor can invest in both these products if he wished to. However, there is no reason why an individual should opt for both especially if they have exhausted the tax-advantaged accounts.
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