There is a long running debate involving the annuity vs. 401k. For decades, people banter trying to prove their point that their personal choice is superior. In order to know which is better, if either, we need to take a quick look at the mechanics of each!
What is an annuity?
According to Investopedia, “an annuity is a contract between you and an insurance company in which you make a lump-sum payment or series of payments and, in return, receive regular disbursements, beginning either immediately or at some point in the future.”
Wow, that was a lot of words. In short, you’re paying an insurance company to buy an immediate or future stream of payments. Now, obviously the insurance company charges a fee for this, right? Well, not in all cases. In many situations such as Single Premium Immediate Annuities (SPIAs), the insurance company prices the product according to the market. This means that you’re getting the exact product you’re quoted with no hidden fees. Pretty simple. This also remains true for Multi-Year Guaranteed Annuities (MYGAs) in many cases.
On the flip-side, we have variable annuities, indexed universal life annuities, and many others which are fee-ridden and can often return less than desirable results. In the past, we’ve discussed some of Oceanview’s “life insurance annuity” options, which to this day, we have no idea what that is. These annuities often claim to use the S&P 500, or another index, to give you “near market” returns. The “near” part comes into play because of the downside protection provided by the insurance company. If the market returns 25%, they’ll give you 10%. This ensures you don’t lose money during a -10% year. Note that this isn’t free, it cost you 15% in the good year!
What is a 401(k)?
For simplicity, we’ll stay with the Investopedia definitions. They state that a 401k is is a retirement savings plan offered by many American employers that has tax advantages for the saver. It is named after a section of the U.S. Internal Revenue Code.
The 401(k) is currently utilized by about 60 million American’s and has approximately $6.5 trillion in cumulative assets. Pretty impressive. These plans are becoming more popular by the day and are quickly solidifying their position as the most simple and advantageous retirement account in America. The account is essentially a brokerage or mutual fund account that accumulates tax deferred money, allowing an individual to purchase securities toward retirement. Oftentimes, employers offer a match percentage to their employees. This creates an extra savings opportunity. At age 59.5, employees can retire and are eligible to withdraw from the 401k penalty free. However, income taxes will be collected at this time.
Annuity vs. 401k
Alright let’s get down to it: Annuity vs. 401k. Which is better? Well, this isn’t a really easy question and there is no simple answer.
First, if you have access to a 401k plan, especially one with a match, you should absolutely be using it! Don’t let someone tell you that a 401k will keep you poor, or that you’re leaving money on the table, etc. If you have a 401k start contributing to it. Automate your savings and build wealth, today!
Second, 401k plans have ERISA protections, which set minimum standards for which the plans must operate. With annuities, you can find hundreds of life insurance companies willing to sell you absolutely terrible products and smile while doing it. If you can dream up a bad life insurance product, it exists in spades. Don’t underestimate the dirty tactics and subpar products of the life insurance industry.
Third, the only good annuity is the SPIA or MYGA. There are specific instances where individuals need guaranteed income and an annuity may be the best means to provide that. SPIA and MYGA products are simple and can easily be explained to anyone smart enough to use a checking account. If you don’t understand the product, don’t buy it!
Lastly, if you have friends that are buying annuities please point them to this article so we can hopefully convince them that they’re wrong. Friends don’t let friends drive drunk. Friends also don’t let friends buy annuities.
Annuity vs. 401k Plans in Summary
When it comes down to the annuity vs. 401k, I didn’t really compare the two because I don’t think they’re comparable. The 401k is the bedrock of the modern retirement system and that shouldn’t even be compared to annuities. The 401k is proven, widely used, and will hopefully ensure the long-term income for millions of American’s in retirement. The annuity is a confusing, fee-ridden, salesperson peddled product that is designed to pay hefty commissions and give the consumer less than market returns. Yuck. Stop reading and go invest in your 401k!