Annuities and 401(k) plans are popular investment instruments for retirement savings. Both offer participants a way to contribute to their funds during their working years, and both offer tax advantages if the contributors wait until after retirement to use that income. Each plan has different structures, benefits and drawbacks, so an understanding of how each type of account works will help participants make a selection that fits their needs.
Annuities are private contracts between the participant and an insurance company. That means the rate of potential return depends on the financial decisions of the insurance company. A 401(k) plan is an investment plan offered by the participant's employer. Non-employees, including volunteers and independent contractors, are not typically offered the opportunity to participate in 401(k) plans. A third-party fund manager makes investment decisions on behalf of the 401(k) plan participants.
Annuities don't carry an annual limit for how much a participant can contribute, but 401(k) plans do. Participants in a 401(k) plan can borrow against their accounts, an option not available to annuity holders.On the other hand, annuity participants can keep their accounts as they change jobs, while 401(k) plan holders must make a choice to either maintain their account under the old employer, move the account to their new employer's 401(k) plan, or roll it into an IRA.
The contributions and growth in both plans are tax-deferred. Participants don't have to pay any income tax on these funds until they withdraw them at retirement. The major tax benefit of a 401(k) is the annual contribution is also tax-deductible. The tax benefit of an annuity is that, since the contributions are funded with after-tax monies, only the investment gains are taxed after withdrawal.
Annuity contracts often contain several fees. Participants who choose to withdraw anything prior to the maturity date must pay a "surrender fee" to the insurer. The surrender fee compensates the insurer for the income lost for the years between the contract's termination and its maturity. While 401(k) plans allow participants to borrow against their funds, the interest rates are often higher than typical bank loans.