A 401(k) is an employer-sponsored retirement account. It allows you to save money for retirement on a pre-tax basis,meaning that you’ll pay taxes on the money when you withdraw it in retirement. In many cases, your employer mayalso provide matching funds to incentivize saving. Although contributions are limited to a certain percentage of yourincome, these tax-deferred investments can grow quickly and provide investors with substantial retirement savings.Annuities, on the other hand, are financial products offered by insurance companies. These warranty-like contracts payout a stream of income during a designated period of time – often the duration of one’s lifetime – and are designed toprovide investors with a secure income. It is important to note that annuities also come with fees, which can varydepending on the types of annuities, income payout and insurance companies.
The following table briefly compares the two types of retirement savings vehicles:
| Characteristics | 401(k) | Annuity |
|---|---|---|
| Tax Advantages | Tax-deferred contributions and matching contributions from employer. The contribution is usually pre-tax. | Tax-deferred growth and income but the contribution is usually after tax. |
| Fees | No surrender fees or up-front fees to establish. Investment funds fees are coming down because employers are more | Fees can vary widely, depending on the product type and the product provider. |
| Income Stability | No guaranteed income stream from 401(k); Investment loses value when markets declines | Guaranteed income stream; Value grows with investment performance gains if it’s a variable annuity. |
| Investment Options | Selected list of investment options so investors can diversify and manage risk | Fixed annuities allow investors to lock in an interest rate and secure principal, variable annuities offer investment for market risk |
| Protection | Generally protected by Federal Insurance up to $250,000 per account | Insured by insurance companies; Some annuities are back by state guarantees. |
Annuity investors should watch out its fees and payouts.
Annuity Fees: the following are common fees you may encounter:
- Administrative Fees: These fees cover the costs of managing and maintaining your annuity contract. They can include administrative expenses, paperwork processing, and customer service support.
- Surrender Charges: Some annuities impose surrender charges if you withdraw funds from the contract before a specified period, typically known as the surrender period. These charges are designed to discourage early withdrawals and vary based on the annuity provider and the length of the surrender period.
- Mortality and Expense (M&E) Charges: M&E charges compensate the insurance company for the risks they assume in providing the annuity. These charges cover the costs of insurance guarantees, including lifetime income provisions and death benefit options.
- Investment Management Fees: For variable annuities, investment management fees are assessed on the underlying investment options within the annuity. These fees cover the professional management of the investment portfolios, including fund management and administrative costs.
- Riders and Optional Benefit Fees: Annuities may offer optional features or riders that provide additional benefits, such as enhanced death benefits or long-term care coverage. These riders typically come at an extra cost, and the fees associated with them can vary based on the level of coverage and the specific terms of the rider.
Annuity Payouts: Annuities offer various payout options to provide you with a regular income stream during retirement. Here are some common payout options:
- Lifetime Income: With a lifetime income option, the annuity pays you a regular income for the rest of your life, regardless of how long you live. This ensures you won’t outlive your income and provides financial security during retirement.
- Period Certain: A period certain payout guarantees income for a fixed period, such as 10 or 20 years. If you pass away before the specified period ends, your beneficiaries receive the remaining payments.
- Joint and Survivor: This payout option covers both you and a designated beneficiary, usually a spouse. Payments continue until the last surviving individual passes away. It provides ongoing income protection for both you and your loved one.
- Lump Sum: Some annuities allow you to withdraw the entire account balance as a lump sum payment. While this option gives you immediate access to your funds, it eliminates the guaranteed income stream.
For long term investors who have had a head start to save in 401(k) at young ages, investing in a 401(k) using a diversified low cost portfolio has more advantages as they can ride out market volatilities and pay less fees along the years. However, for those who are near retirement or who are concerned about retirement income stability and are seeking guaranteed, protected lifetime income, they can look at annuities. They just need to carefully analyze their fees and payouts to make a decision.
It is important to consult with a qualified financial professional to ensure that you are making the right decision for your unique financial situation and retirement savings goals.