When it comes to choosing how you want to invest money for retirement, there is no shortage of choices. Perhaps two of the most common options are annuities and 401(k)s. But, which is better? Well, the answer to that may not be straightforward for everyone. Let’s discuss the basics of each and then do some comparing.
What is an annuity?
Simply put, an annuity is a contract between you and an insurance company. You, as the annuitant, pay either a lump sum or monthly premiums, and in turn, the insurance company promises to provide you with a future stream of income (usually for life).
What is a 401(k)?
A 401(k) is an employer-sponsored retirement savings plan that allows you to save and invest money directly from your paycheck before taxes are taken out. Many employers will match contributions up to a certain percentage.
So, what’s the difference between an annuity and a 401(k)?
Though both are used to provide future income, annuities and 401(k)s have several key differences that will likely make or break a retirement planner’s decision to adopt one or the other. Here’s what to know:
An annuity is an insurance product sold by an insurance company, whereas a 401(k) is a program implemented by your employer. You cannot invest in a 401(k) if the company that you work for doesn’t offer one.
Most annuities have no contribution limits. With a 401(k), the IRS sets yearly limits on how much money can be contributed.
An annuity guarantees a specific monetary value, monthly, for the entire term of the contract. Since money within a 401(k) is invested in various ways, its value can fluctuate greatly depending on market changes.
Rate of Return
Many annuities (such as fixed index) will allow money to grow based on an index (like the S&P 500). This means that when the index is up, you earn interest, but when it’s down, you don’t lose a penny. In contrast, money invested in a 401(k) can produce a large rate of return with no cap, but significant amounts of money can also be lost depending on the market.
Which is better?
That depends. If you’re nearing retirement, or already retired, and need guaranteed income for life, then an annuity is probably something you’ll want to discuss with your financial advisor. If you’re still working, especially if you’re under the age of 40, check with your employer to get the specifics on their 401(k) program; taking a risk at this juncture in life might be a better option.
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