Variable Annuity vs. 401(k)
There are several popular methods for saving income for retirement. Two of them are 401(k) plans and variable annuity plans. In many cases, these two retirement plans share similarities. They use many of the same investment pools. They share similar tax-deferment benefits. And they share similar penalties for early withdrawals. But how you invest is both plans is the big difference.
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Definition
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A 401(k) is a retirement plan focused on allowing employees of companies to place a pretax portion of their salary into a retirement account. Usually, 401(k) accounts are based on mutual funds that allow investors to accrue earnings as time passes. In many cases, if you contribute to a 401(k), your company will match at least part of the contribution.
A variable annuity is a much different investment option. A variable annuity is a contract between an investor and a life insurance company in which you invest money into the annuity and accrue interest over time, according to the Securities and Exchange Commission.
Tax Implications
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With a 401(k), there are no tax implications when you make the investment. Because investors contribute before taxes are taken out, those contributions are not exposed to payroll taxes.
In the case of a variable annuity, there are two ways you can contribute funds. The first is pretax, but in this case the plan must be a qualified plan under the Federal Tax Code. In most cases a qualified plan is offered only through an employer. If you invest in a non-qualified plan, that means you will pay taxes on the money you invest.
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Investment Types
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Investing in a 401(k) means you'll probably be putting your money into a mutual fund. A mutual fund is a large investment pool that spreads fees and expenses among its hundreds or thousands of investors. That keeps costs down. Although 401(k) plans can invest in such things as bonds and real estate, most mutual funds revolve around stocks. You can control the percentages of the types of stocks your plan invests in. In other words, you can invest a portion of your money in high-risk stocks, and another portion in lower-risk items.
Investors in a variable annuity typically invest in a combination of stocks, bonds, and money market plans. As in a 401(k), you can invest percentages of your money in different levels of risk.
Payout
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Both a 401(k) and a variable annuity require you to normally wait until age 60 to begin withdrawing money. Investors in a 401(k) have several options, including a lump-sum withdrawal, rolling the money over into other investments, leaving the money in the current account and accumulating more interest, or taking periodic distributions.
With a variable annuity, you have two choices--take a lump-sum payment or periodic payouts. In any case, your money will be taxed at withdrawal.
Before Maturation
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If you choose to withdraw your funds early, you'll pay some penalties, regardless of whether it's a 401(k) or a variable annuity. With a 401(k), there is a 10 percent penalty for early withdrawal on the taxable amount, which is usually taken out of the money you withdraw. This is on top of any U.S. income taxes you'll have to pay.
With a variable annuity, if you withdraw early you could pay a "surrender charge." This is a percentage of the principal you must pay back to the insurance company, in addition to any income taxes you'll have to pay.
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