401(k) vs Annuity: Difference and Comparison

Investments are a key part of life. One has to save on one hand and invest the savings on the other hand. This helps to live a better retirement life without any tension.

Now, when it comes to investment, people nowadays invest in 401(k) and annuities instead of keeping the money in the bank.

These two provide better returns than a bank and are safe if invested at the right time and place.

Key Takeaways

  1. 401k is an employer-sponsored retirement plan allowing employees to save and invest pre-tax dollars.
  2. An annuity is a financial product that provides fixed payments over a predetermined period.
  3. 401k plans are more flexible and offer various investment options, while annuities offer a guaranteed income stream.

401(k) vs Annuity

The difference between 401(k) and annuities is that in the case of a 401(k), the money is currently deducted from the tax bill. This money grows without being taxed, and the income tax is paid at the time of withdrawals. An annuity is an insurance contract with a lump-sum payment followed by payments made over a regular period.

401k vs Annuity

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The 401(k) is a plan in which some part of an employee’s gross income is deducted from his/her bank account. This whole part of the deducted money is paid at the time of retirement.

The employee has to pay the tax on this money. It is described as a defined-contribution pension account present in subsection 401(k) of the Internal Revenue Code of the US.

While an annuity is a series of payments made at regular intervals, it may be regular deposits to a savings account, monthly home mortgage payments, pensions, etc.

The main objective of an annuity is to provide some decent income in an individual’s retirement life in a stealthy manner.

Comparison Table

Parameters of Comparison401(k)Annuity
Buying/ Contribution If only the employer has such a plan, an individual can contribute to one such plan. Anyone can buy an annuity according to their desired preferences.
FeesIt is easy to figure the additional charges for a 401 (k) plan. The charges are not always fixed and can be considerably higher than the former.
InheritanceHeirs to someone can own the same 401(k) plan. An annuity plan expires with the death of a person.
Withdrawal Fees If withdrawn before the age of 59.5 years, a penalty of 10% and the tax is to be paid. They have their penalties along with the tax if withdrawn before the surrender period.
CommissionThere is no commission to be paid in this case. The commission is paid according to the plans taken by the investors.

What is a 401(k)?

A 401(k) plan is a retirement savings plan that is offered by many American workplaces that gives an advantage in saving taxes.

When an employee enrols in a 401(k), he or she agrees to have a portion of each paycheck deposited directly into an investing account. The employer may match a part or all of the contribution.

The 401(k) was a plan designed by the US to encourage citizens to save for their retirement. One can save enough money for their retirement life through this plan.

Now, the 401(k) plan is of two types, traditional 401(k) and Roth 401(k).

Employee contributions to a traditional 401(k) are withheld from gross income, which means the money comes from the employee’s paycheck before income taxes are curtailed.

As a result, the total amount of contributions for the year is deducted from the employee’s taxable income. The tax paid on this amount is during the withdrawal time.

A Roth 401(k) is similar to a traditional 401(k) plan. A part of an employee’s gross is withheld from the gross income. However, Roth accounts cannot be availed by all employees.

If the Roth is available, the employee can choose one or the other, or a combination of the two, up to the yearly tax-deductible contribution limitations.


What is an Annuity?

An annuity is a distributed insurance contract that promises to pay out cash invested in a set income stream in the future. Annuities are purchased or invested using monthly premiums.

The holding institution has to pay a series of payments over a fixed interval or for the rest of the annuitant’s life.

Annuities are mostly utilized for retirement planning and to mitigate the danger of outliving one’s resources. Sometimes, the assets of one’s life are not enough to sustain their standard of living.

In that case, people look out to insurance companies to purchase an annuity contract.

Mostly, annuities go through two phases. First comes the accumulation phase, which (as the name suggests) is the period of the annuity being funded, or the amount is accumulated at once.

At this stage, there is no need to pay any tax. Then comes the annuitization phase, when the payouts begin.

Index funds and mutual funds are prime examples of annuities. There is a time before the investor cannot withdraw the money invested, known as the surrender period.

This time may be several years. In case of an urgent withdrawal, the individual might have to pay a surrender charge to withdraw the money.


Main Differences Between 401(k) and Annuity

  1. The agents of a 401(k) plan do not receive any financial compensation, while the agents receive a sales commission at the time of selling an annuity.
  2. No additional fees are charged for a 401(k) plan, while the person investing in an annuity needs to pay some charges, especially when the person wants to add some riders at the time of initial investment.
  3. The returns in a 401(k) plan are not fixed, whereas the returns in an annuity are mostly fixed.
  4. There are some pre-conceived notions for a 401(k) without any exceptions, while an annuity does not have an exception, as the investor himself has the option to select one.
  5. There is no stipulated time to invest money in a 401(k) plan, whereas the period in an annuity is fixed.
Difference Between 401k and Annuity
  1. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1656093
  2. https://www.sciencedirect.com/science/article/pii/S0378426620300510

Last Updated : 13 February, 2024

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