Let's start with a quick overview of what an annuity is:
An annuity (available in several varieties) is really a contract between you and an insurance company. You give the insurance company your money and in return they promise to provide you with periodic payments for a certain amount of time, or, until a specified event occurs, i.e., the death of the person receiving the payments.
You may opt to receive these payments monthly, quarterly, annually, as a lump sum or even as a lifetime income stream. These tax-deferred investments are sold by insurance companies and allow you to grow your nest egg tax deferred and then, when you're ready to retire, guarantee you an income stream that you can't outlive.
A 401(k) is a qualified retirement plan that allows eligible employees of a company to save and invest for their own retirement on a tax-deferred basis. Not everyone can invest in a 401(k). You can only invest in a 401(k) if you work for a company that offers one. Because a 401(k) program is tied to an employer, while an annuity is not, a 401(k) can be left in place if an employee changes jobs, and in other cases it may have to either be transferred to another employer's 401(k) program or rolled over into an individual retirement arrangement.
Within the parameters of the plan and IRS contribution limits, it's entirely up to you to decide whether or not you want to participate in the 401(k) and how much you will contribute each paycheck. Your employer may also choose to make contributions to the plan but that's entirely optional. Your contributions are deducted from your salary on a pretax basis so that by contributing to a 401(k) you get to lower the amount you pay in current income taxes. You will not owe income taxes on the money contributed until you withdraw it from the plan.
Only an employer is allowed to sponsor a 401(k) for their employees.
It’s actually the employers who run the plan in accordance with laws and current rules and regulations as well as provisions of the plan itself. The employers decide who is eligible for the plan and how much and when they can contribute, as well as how much, if any, matching contributions the employer will put into the plan. There are limits to how much an employee and employer can contribute to a 401(k). These limits are set both by provisions of the plan as well the IRS.
Annuities on the other hand are not a work sponsored retirement plan. There are no restrictions on adding money and you can invest in an annuity whenever you want. There's also no limit to the amount of money you can invest in annuity. As stated before, annuities are private contracts between an insurance company and individuals. 401(k) plans are between an employer and its employee.
Both annuities and 401(k)s delay taxes on your investment growth so you do not need to pay tax on your investment gains until you begin taking money out in retirement or begin taking withdrawals Perhaps the best advantage annuities have over 401 (k)s is their ability to provide guaranteed lifetime income, irrespective of market conditions or how long you live.
401(k) plans are susceptible to market volatility and should be in line with your long term goals and risk tolerance. The 401(k) does offer an extra tax benefit. You are allowed to deduct your 401(k) contributions from your taxes for the year the payment was made this lowers your taxes for today while saving money for your future. You cannot deduct your annuity contributions you can only delay the taxes on your investment gains.
As with any investing decision, when determining whether a 401(k) or annuity is right for you, look at your entire financial situation, figuring out your goals and risk tolerance, either on your own or with the help of a financial professional and always keep your long-term goals in mind.
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