Comparing Annuities to Employer-Sponsored Plans (401(k) and 403(b)): A Comprehensive Guide

Annuities and employer-sponsored plans like 401(k)s and 403(b)s each have their own unique features, advantages, and drawbacks.

This guide will compare these options in terms of safety, investment choices, returns, taxation, and other important considerations to help you make an informed decision.

After you leave an employer, you can always roll your sponsored plan into an annuity tax-, and penalty-free.

How safe are they?

Annuities:

One of the primary benefits of annuities is their ability to offer guaranteed income, often for life, depending on the type.

401(k) and 403(b):

Both 401(k) and 403(b) plans are subject to market risks, as their performance depends on the chosen investment options, such as stocks, bonds, and mutual funds. While safer, more conservative investment options are available, the overall safety is generally lower compared to fixed annuities.

Employer Matching: Provides additional security by essentially offering "free money" that boosts your savings.

What are the investment choices in each?

Annuities:

Annuities offer a wide range of investment choices tailored to your risk tolerance and financial goals as they can be allocated to a myriad of different indexes, both stock and other asset class ETFs. You can adjust index allocations annually with your carrier.

401(k) and 403(b):

Employer-sponsored plans also offer a broad range of investment options. Participants can typically choose from a list of mutual funds, stocks, bonds, and other securities, however, the flexibility is contingent on the options provided by the plan administrator.

How do returns compare?

Annuities:

Fixed Annuities provide steady, predictable returns, though they might be lower compared to market-linked investments.

401(k) and 403(b):

The potential returns are tied directly to the market performance of the investments you choose within the plan. Higher risk can mean higher returns, but also greater potential for loss.

How are annuities taxed versus employer plans?

Qualified Annuities:

• Tax-Deferred Growth: Investment grows tax-free until you start withdrawing, similar to retirement accounts.
• Distributions: Withdrawals are taxed as ordinary income.

401(k) and 403(b):

• Tax-Deferred Growth: Contributions are pre-tax and grow tax-free until withdrawal.
• Distributions: Withdrawals are taxed as ordinary income, and early withdrawals (before age 59½) may incur a 10% penalty.

Other Important Considerations

Annuities:

• Fees: For some annuities, especially those for older savers, fees can be higher due to mortality and expense risk charges, administrative fees, and possible surrender charges if cashed in early.
• Lifetime Income Option: Provides a lifelong income stream, making budgeting for retirement simpler.

401(k) and 403(b):

• Employer Contributions: Matching contributions are a significant advantage, boosting your retirement savings effectively. When you’ve left your previous employer, this matching stops.
• Loan Provision: Some plans allow borrowing against the balance, which can be beneficial but comes with risks if not repaid.

Conclusion

Choosing between annuities and employer-sponsored plans like 401(k)s and 403(b)s depends on your financial goals, risk tolerance, and retirement needs.

Annuities provide more secure growth and offer market protection, while 401(k)s and 403(b)s offer greater investment flexibility and potentially higher returns, supplemented by employer contributions.

Understanding the safety, investment choices, returns, and tax implications of each option will help you craft a retirement strategy that fits your unique situation.