What Is the Difference Between Annuities & 401k Plans?
Annuities are investments made with deferred payments after a specified period of time. Annuities are private contracts between an insurance company and individuals. 401k plans are investments made with deferred payments usually after retirement. These plans are between an employer and its employee. The employees elect to have a part of their income invested to be paid after retirement. The employer decides the method of investment of funds.
The main features of annuities are that assets can be converted into a series of periodic payments for a specific period of time after which interest is paid, based on the terms of the contract. The accumulated payments yield a monthly income, a fixed maturity income or a death benefit in accordance with the terms of the contract. Under the 401k plan, money is saved till the employee retires. The contributions to 401k plans are tax free. A loan can be taken for building a house from the contributions.
The time period in an annuity is the accumulation period or the time between the investment and the time from which payments are made by the insurance company. Once payments start, the distribution period begins. The time frame in a 401k plan is the time between election to participate in the plan offered by the employer and the retirement of the employee.
The main considerations of investing in an annuity are to make sure that the investor is in good health and will be able to enjoy the fruits of the investment. The insurance company should be solvent. The annuity contract should not have hidden fees that eat into the investment. Emergency and early withdrawal terms should be convenient. The points to consider before participating in a 401k plan offered by an employer are the restrictions placed upon borrowing from the plan. The rules about what happens to the investment in case the employee changes jobs are an important consideration, too.
Annuities can be risky if the investment is made with an insurance company that does not have a solid reputation. The entire investment will be lost if the company goes bankrupt. Penalties are stiff for early withdrawals, and to get the best benefit the time frame has to be strictly adhered to. 401k plans also come with inherent risks. A change of job may cause a large decrease in the returns. A loan taken on the investment will result in lesser payouts after retirement. The interest rates for loan payments can be very high.
Annuities don't often pay back the principal in full. Unlike mutual funds, annuities have little or no tax benefits, despite popular belief. 401k plans do not automatically renew if the employee changes jobs. The employee needs to give notice within a very strict time frame or the investment could be forfeited. Taking a loan on the plan is both an advantage and disadvantage. Immediate expenses can be met, but the loan reduces the final payouts after retirement.