Annuities and 401(k) plans are two of the most common ways to save for retirement.

While similar in some ways, they also have important differences, as well as times you can use them. Below, we detail what you should consider when deciding how each could factor into your retirement plan.

However, since everyone’s financial situation is different, it could be a good idea to speak with a financial advisor.

Consulting a fiduciary financial advisor can be a great first step to helping make sure you’re on track to meet your financial goals, regardless of your income level. That's why we created a free tool to help match you with up to three financial advisors.

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Research suggests people who work with a financial advisor feel more at ease about their finances and could end up with about 15% more money to spend in retirement.¹

A 2022 Northwestern Mutual study found that 62% of U.S. adults admit their financial planning needs improvement. However, only 35% of Americans work with a financial advisor.²

Annuity vs. 401(k)

A 401(k) is a tax-deferred retirement account you can often get through your employer.

Contributions are usually a regular deduction from your paycheck. You don’t have to pay taxes on earnings contributed to a 401(k) at the time you make them. An exception to this, though, is a Roth 401(k), which you fund with after-tax money.

The money in your 401(k) is invested in mutual funds, exchange-traded funds (ETFs) or other investments as you choose. When it comes time to stop working, you can withdraw funds from the account to pay for your retirement.

You don’t have to pay taxes on the money in a 401(k) until you withdraw it. The funds in a Roth 401(k) are, again, exempt, as you’ve already paid taxes on your contributions.

Put simply, an annuity is a contract you enter into with an insurance company. Like with any other insurance policy, you’ll pay a premium up front in exchange for the promise of money paid to you down the line. Unlike an auto or home insurance policy, though, collecting that money is not contingent on you having some sort of accident or incident; you are guaranteed a payout at a predetermined time.

The details of an annuity — your premium payments, how much you’ll get in retirement, how often you’ll receive dispersals and for how long — are all determined when you purchase the annuity. Again, make sure you take your time to research and choose the best product for your situation.

Whether you choose a 401(k) or annuity, fiduciary financial advisors are obligated to work in your best interest, and could help you consider your options and the tax considerations associated with each.

This free quiz can match you with up to three fiduciary financial advisors who serve your area in just a few minutes.

Major Differences Between Annuities and 401(k)s

While anybody can buy an annuity, only people whose employers have 401(k) plans can contribute to one. If your employer doesn’t have a 401(k) program, you cannot contribute to one. Anyone who’s self-employed can set up his or her own 401(k), though.

Fees are another major differentiator. It could be quite easy to check the fees you’re paying for your 401(k). To do this, simply ask your plan administrator for an explanation of any fees charged to your account. Annuity fees are much harder to figure out and are often significantly higher. In particular, you may pay steep sales commission fees for an annuity, benefit rider fees and more.

If you withdraw funds from your 401(k) before age 59.5, you may have to pay a 10% early withdrawal penalty, in addition to the income tax due on the amount you withdrew. Annuities have their own early withdrawal fees, as well as annuity surrender fees. Annuity surrender fees are reduced as time goes by, meaning they’ll usually disappear after five years.

Another way annuities and 401(k) accounts differ is you can borrow from your 401(k), while you can’t borrow from an annuity. Plus, most annuities provide unchanging regular payments, which means you won’t have inflation protection.

Inheritance is another point of discrepancy. Your heirs can inherit your 401(k), while annuity payments typically cease with your death. Some annuities, however, allow you to pay more to purchase an annuity with a death benefit that will, like a regular life insurance policy, pay money to designated beneficiaries.

To help best understand the differences between 401(k)s and annuities, it could be helpful to speak with a financial advisor. Click here to get matched with up to three advisors who serve your area in just a few minutes.

Making Withdrawals From Annuities and 401(k)s

Another big difference is that an annuity could offer a guaranteed payment for as long as you live. That means, at least with most annuities, you can’t run out of money. A 401(k), on the other hand, can only give you as much money as you have deposited into it, plus the investment earnings on that money.

If the market goes down, annuity payments keep coming. The same can’t be said of a 401(k), which is subject to market cycles. That also means that if your 401(k) investment choices do well, you could have more money. With an annuity, you don’t benefit if the market is up unless you take your chances with a variable annuity.

There are limits on the amount you can contribute to a 401(k). This typically increases annually to account for inflation, and stands at $23,000 for the 2024 tax year. If you’re 50 or over, you can put in another $7,500 for 2024 as a “catch-up contribution.” Your employer may match all or part of your contributions as well, which will further increase the amount going into your 401(k).

With annuities, there are no such limits, so some people buy them with one-time payments of sometimes $1 million or more. If you’ve maxed out your 401(k) contribution and want to sock away more, an annuity could be something to consider.

When Should You Choose an Annuity or a 401(k)?

Choosing between an annuity and investing in a 401(k) is going to depend on a number of factors from how much you can save to how much you need to earn during your retirement years.

Annuities and 401(k)s could potentially offer respective long-term savings, tax-deferred growth and beneficiary options to pass down assets outside of the probate process.

In fact, a financial advisor could potentially recommend investing in an annuity later in life, especially if you are still employed and haven’t maxed out your 401(k).

In reality, choosing which to pursue for your retirement comes down to your individual financial situation.

Consulting a fiduciary financial advisor could help you determine a plan that factors your assets and taxes into your overall retirement and estate-planning goals. Fiduciaries are obligated by law to act in your best interest and any potential conflicts of interest must be disclosed.

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