What Is the Difference Between Annuities & 401k Plans?
There are differences when it comes to annuities and 401ks, despite the fact that both are retirement savings vehicles. Annuities are issued by insurance companies; 401k plans are typically offered by mutual fund companies and overseen by third-party administrators.
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Annuity Definition
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Annuities are retirement accounts issued by insurance companies. They come in many shapes and sizes--fixed annuities, fixed index annuities, variable annuities and immediate annuities. The first three types are deferred annuities, and they're used in similar ways as retirement savings vehicles such as a 401k. Deferred annuities allow the owner to invest a single sum of money or regular installments on a tax-deferred basis. Money inside an annuity grows tax-deferred and can be subject to an IRA-imposed 10 percent penalty if funds are withdrawn before age 59 1/2.
401k Definition
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A 401k plan is a retirement savings vehicle offered by employers to their employees. It offers the chance to save on a pre-tax or after-tax basis, with the monies coming directly out of the employee's paycheck. Some employers give an incentive to employees to contribute to the 401k plan by offering a matching program. Money inside a 401k grows tax-deferred and carries a 10 percent IRS-imposed penalty if funds are withdrawn before age 59 1/2.
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Differences
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Annuities are offered by insurance companies; 401ks are typically offered by mutual fund companies and sometimes have third-party administrators that oversee the plan. Variable annuities resemble a 401k plan in that the money grows based on how mutual funds perform in the overall market. Only employees of companies that offer 401k plans have access to this special retirement vehicle. Annuities are open to the general public. A 401k plan usually allows loan options, while annuities do not. Be sure to read the summary plan description (SPD) to understand how the 401k loan privilege within your plan works.
Tax Considerations
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A 401k and an annuity both offer tax-deferred growth. If each vehicle is funded with pre-tax dollars, every withdrawal is subject to ordinary income tax. If funded with after-tax dollars, interest and gains earned on the contributions are subject to ordinary income tax.
Learning More
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The summary plan description (SPD) is a great place to learn how your company's 401k works. For those considering an annuity, financial advisers can explain the pros and cons of investing in such vehicles. Be sure to read all policy specifics before investing any money.
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