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Annuity vs 401k: What’s the Difference?

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Annuity vs 401k, always part of the topic of conversation with retirement. These are two separate ways to ensure you get income after you stop working.

However, both operate differently, providing distinct advantages. Knowing how they work is vital for your future. Here’s are the differences between an annuity and a 401k.

The 401K

The 401k is often the most common retirement plan offered for private business employees. Each paycheck, a portion of your wages gets deductions that head into your 401k plan. The money then becomes invested in mutual funds and other similar vehicles. There are also some cases where the employer may double contributions or add to them, depending on your company’s policies.

What differentiates the 401k from other plans is that the money you pay is pretax dollars. That means that it will head into the account and grow tax-deferred. Tax will only apply when you retire. It is often an advantage, as most people will get taxed at a current rate which is often lower than what it was before they started the plan.

An alternative to the traditional 401k is a Roth 401k, which is a taxed version of the plan. You pay the tax upfront, and it grows tax-free, ensuring its final amount. Both types can be advantageous depending on the tax environment if your company offers this option.

You’ll likely choose a traditional 401k if you’re currently in a high tax environment. You’ll save money, if you expect a lower bracket when you retire. The opposite is true for a Roth 401k. You’ll pay tax now because it is lower than your expectations when you retire.

There is some choice with the investments your money can go into while it’s in either a traditional or Roth 401k. Aside from mutual funds, you can also choose stocks or bonds. However, there is a limit to the contributions you can make annually. This limitation includes how much the employer can add to your account.

While your employer may be responsible for handling part of your contributions to the 401k, the plan does not tie up with them. It can be a way to encourage people to stay within a company, but there’s always an option to bring it with you. For example, if you enter new employment, you can roll over your current 401k plan into another account such as an IRA (Individual Retirement Arrangement),  or an indexed annuity which can be structured to provided you lifetime income in retirement..

Why Choose a 401k?

A 401k gives you the option to build a retirement fund without affecting your current lifestyle. You’ll be getting money with it deducted, so you won’t have to worry about setting aside extra money for it. It is also possible to add contributions.

One reason people like 401ks is because their employer adds contributions, boosting your savings. You also don’t have to worry about contributing manually, as the deductions are automatic. The tax stipulation can also be advantageous if you are in a high-tax environment currently.

Since you are investing the money in a 401k, the money can grow. It depends on the investment you choose and the state of the market by the time you withdraw. Starting a 401k early on can also allow it to grow more because the earnings in its investments can compound.

401k Considerations

There are caveats when dealing with a 401k. One of the biggest is the tax rule. If you happen to withdraw during a higher-tax environment, you end up losing more money. It can also be deceiving to think you’re getting more than expected because tax only applies once you begin withdrawing.

Another reason why some people don’t like the 401k so much is the limited investment options. You can only choose what’s available from your employer. There is no possibility of exploring other investment options that are not in their peripheral.

The concern many have is the withdrawal clauses with the 401k. For one, withdrawing before the designated time could result in penalties that can lower the money in it even further. You also cannot keep it beyond the age of 72. You’re required to withdraw a minimum each year starting from that age, meaning you cannot leave it to keep growing for longer.

The Annuity

An annuity is an insurance product specifically designed for retirees. By buying an annuity, you can have the assurance that you’ll gain regular income for the rest of your life. It’s a form of protection that also has the potential to grow like the 401k if you choose to defer it before withdrawing.

There are two ways to approach the annuity. The most common way is to contribute to it regularly, allowing it to grow over time as money becomes a part of investments. The other way is to pay a lump sum to the insurance company. You can begin an annuity and receive payments at the period they set by doing this.

Here are several types to choose from:


The indexed annuity is tied to the performance of a market index. For example, if it is tied  to the S&P 500, your annuity value will grow alongside the S&P as it grows.  But, the beauty of an indexed annuity is that if the S&P 500 were to go negative in a given year, your annuity value won’t lose its value.   An indexed annuity like this can also be structured to provide you with lifetime income in retirement, regardless of how long you live. 


The fixed annuity assures you’ll get the exact rate despite the environment. Even if the investments crash, the insurance company will provide you with the promised amount. It can bring more assurance to the annuity at the cost of potentially missing out on situations where the investments are growing.


Variable annuities will provide payments depending on the conditions of your chosen market. For example, if your money is in the stock market, you’ll get more if it performs well. Conversely, you could get less money if it is in a general downtrend. It’s a riskier option that could pay off significantly better if the market performs well and often has higher fees.

Why Choose an Annuity?

An annuity gives an assured income during retirement. You can opt to get a fixed payment no matter what, with everything backed by the insurance company.

Another advantage it brings is that there is no limit to your contributions to the annuity. You can continue giving to it and allow it to grow. The lack of limitation means that you can always choose to add more to it while it’s deferred.

Annuity Considerations

While an annuity can provide significant protection against losing money in the stock market while providing lifetime guaranteed income, its upside is more limited than the stock market.   There is almost always a tradeoff between risk and return when planning for your retirement, which is why a diversified retirement plan with exposure to both the markets, and a low risk guaranteed income annuity is a popular choice for many retirees. 

Lastly, annuity contracts can be complicated at first and you need to fully understand the features of the annuity you may be considering.   It is important to work with a financial professional that can help you understand the options available to you to ensure your retirement goals are achieved..

The Verdict

When people consider the 401k vs. annuity battle, they believe they have to choose one or the other. However, with retirement, it’s always good to have multiple sources of income. It provides the assurance that you have enough to live on when you stop working. Most people only have the 401k, and they soon find out that it isn’t enough to last during their lifetime.

With an annuity, you can have guaranteed money to enjoy the rest of your life. Buying it alongside your 401k will supplement your retirement income so you can enjoy your latter years.

If you have more questions, Safe Wealth Plan can connect you with a licensed agent or registered investment advisor. 

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About the Author: Benjamin Hulburt

Benjamin Hulburt - Safe Wealth Plan