What’s the difference between an annuity and a 401(k)?

Signing up for annuities or 401(k) plans is a common way to prepare for retirement. While both can help you build financial security, they serve different purposes. A 401(k) focuses on growing your savings with potential employer contributions, while an annuity converts individual contributions into regular payments.

Read on to learn how these strategies compare and find the option that aligns with your retirement goals.

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What’s an annuity?

An annuity is a contract with an insurer that can provide income after a set amount of time. You can fund an annuity with either a lump sum or multiple contributions. In return, the provider commits to sending you payouts either right away or at a later date. 

There are various types of annuities to choose from, including the following:

• Fixed annuities offer consistent payments and a guaranteed minimum interest rate. Depending on the contracts’ terms, they may not adjust for inflation.
• Indexed annuities tie returns to a market index while ensuring a minimum payout, blending features of fixed and variable annuities.
• Immediate annuities begin payouts as soon as a month after you purchase them.
• Variable annuities invest in funds tied to market performance. This gives you the opportunity to earn higher returns, but it can also cause payouts to decrease when the market underperforms.
• Deferred annuities allow funds to accumulate over time and delay payments to a future date of your choosing.

Each of these accounts has its own pros and cons, but overall, contribution to annuities can be a relatively low-risk strategy that helps you plan for the future.

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What’s a 401(k)?

A 401(k) is an employer-provided account that helps employees save for retirement. With this plan, your company puts a portion of your salary toward various investment options of their or your choosing, such as mutual funds, target-date funds, or company stock. And many employers contribute extra money by matching a percentage of what you save.

There are five types of 401(k) plans organizations may offer:

• Traditional 401(k) plans allow pretax contributions, tax-deferred growth, and employer matching, with withdrawals taxed in retirement.
• Safe harbor 401(k) plans also offer pretax contributions and tax-deferred growth. But they require employer contributions, and they’re exempt from certain nondiscrimination tests that ensure highly paid employees don’t receive more benefits than others.
• SIMPLE 401(k) plans are designed for small businesses with 100 or fewer employees. They require employer deposits and offer lower contribution limits than traditional 401(k)s.
• Roth 401(k) plans combine elements of a Roth IRA and traditional 401(k) to create a unique investment opportunity. Employees make after-tax contributions, which allow for tax-free growth and withdrawals. With these plans, employer matching is optional.
• Solo 401(k) plans are for self-employed individuals and business owners with no full-time employees. These plans allow high contribution limits and both pre and after-tax deposits.

Since most 401(k)s are tied to your employer, it’s important to understand what happens to your funds if you decide to leave your job. Some accounts allow you to keep your savings in your former employer’s plan, although you can’t make any further contributions to it once you leave your job. 

Alternatives include moving the money into an IRA, transferring the funds into your new employer’s plan, and withdrawing the savings as cash. Your account’s type and terms impact these options, so research your choices before you leave your job.

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Annuity vs. 401(k) for retirement: 6 key differences

Even though they’re both retirement savings strategies, a 401(k) isn’t an annuity — here are six primary differences between the two.

1. Contribution restrictions

401(k): The IRS sets new contribution limits annually, and in 2025, you can invest up to $23,500. If you’re 50 or older, the IRS allows for higher catch-up contributions, bringing your total to $31,000. And if you're between 60 and 63, that amount increases to $34,750. It’s important to note that employer matching doesn’t affect this cap — it’s strictly for individual payments. 

Annuity: There are no government-set contribution limits for annuities but, in rare cases, the insurance company could impose caps.

2. Employer participation 

401(k): Employers offer 401(k) plans and may provide matching contributions, which can increase your savings.

Annuity: Individuals purchase annuities from insurance companies, and annuities don’t involve employer contributions or matching funds.

3. Tax implications 

401(k): In most cases, contributing with pretax dollars lowers your taxable income for the year, as you’ll pay taxes on the withdrawals instead.

Annuity: When you buy annuities with pretax dollars, you'll pay ordinary income taxes on the entire withdrawal amount. But if you use after-tax dollars, you'll only pay taxes on the earnings or interest portion of the annuity, not the principal.

4. Withdrawal regulations

401(k): After reaching 59½, you can withdraw payments from your 401(k) without fees. Funds removed before this age are subject to a 10% penalty, and you’ll also pay income tax on the amount you take out.

Annuity: Annuities frequently come with early withdrawal fees and surrender charges, which disappear once the account matures. Withdrawals of taxable amounts are subject to ordinary income tax and if made before age 59½, may be subject to a 10% federal income tax penalty. Distributions of taxable amounts from a nonqualified annuity may also be subject to an additional 3.8% federal tax on net investment income.

5. Risk 

401(k): A 401(k) may include stocks, mutual funds, and other assets that change in value based on the market. If these investments don’t do well, the value of your 401(k) can decrease. However, this volatility also offers growth potential — when the market performs well, so does your 401(k). A 401(k) can offer a wide variety of investment options with varying risk.

Annuity: Different types of annuities come with more risk than others, so it’s best to choose a plan that best suits your financial goals. For instance, fixed annuities offer more consistent payouts, while variable annuities have the potential for higher earnings.

6. Investment options 

401(k): Plans are subject to the investment options your employer selects, such as mutual funds, target-date funds, and company stock.

Annuity: Variable annuities can allow you to invest in stocks, bonds, and mutual funds. These investment options vary by each unique variable annuity. While others can have interest credited linked to indexes like the S&P 500^® or NASDAQ. Before purchasing an annuity, decide how much tolerance you have for market volatility.

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When should you choose an annuity versus a 401(k)?

Deciding between an annuity and a 401(k) depends on your retirement goals, financial needs, and risk tolerance. 401(k)s offer higher growth potential since they often benefit from employer contributions. But if you’re looking for a straightforward approach to retirement planning that may offer a consistent income stream, an annuity could be the right choice for you.

Thankfully, you don’t have to pick just one — instead, you could combine both for your retirement strategy.

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Can you roll over an annuity into a 401(k)?

Yes, it’s possible to move an annuity into a 401(k), but only in specific cases. Generally, you can only perform direct rollovers if the annuity is held within a qualified retirement plan, such as an IRA. Talk to a financial advisor to weigh your options and understand the tax effects related to your retirement goals.

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¹ Annual Percentage Yield (APY) rates are subject to change at any time. All guarantees are based on the financial strength and claims paying ability of the issuing insurance company.

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SteadyPace™ is issued by Gainbridge Life Insurance Company (Zionsville, Indiana).

This communication is for informational purposes only. It is not intended to provide, and should not be interpreted as, individualized investment, legal, or tax advice.

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