Investing: 401(k)s vs Annuities vs Mutual Funds | Senior Finance Advisor (2024)

INVESTMENT MANAGEMENT

May 22, 2019

CATEGORY

May 22, 2019

When it comes to saving for retirement, there are a plethora of options available. Three of the most prominent options are 401ks, annuities, and mutual funds. While these three financial planning options have a lot in common, there are important differences between them and it can be hard to know which one makes the most sense for your unique situation.

Learn about the important differences between 401(k)s, annuities, and mutual funds to make the best decision for your financial future.

401k

A 401(k) is usually offered only through an employer and is a tax-deferred retirement account that employees contribute money into throughout their career. Employees usually deposit money into a 401(k) through a regular paycheck deduction. Taxes are not paid on earnings contributed to a 401(k) when they are made, with the exception of a Roth 401(k), which is funded by after-tax money. Employees often match a percentage of what employees have contributed into the 401(k).

Funds in a 401(k) are then invested into mutual funds, exchange-traded funds (ETFs) or other investments. When the employee retires, funds can be withdrawn from the 401(k) to pay for retirement. Funds withdrawn from the 401(k) are taxed, except for a Roth 401(k) because taxes have already been paid at deposit. If funds are withdrawn from the 401(k) before the age of 59.5, there is an early withdrawal penalty of 10 percent in addition to the income tax on the amount withdrawn.

Additionally, a 401(k) has contribution limits. For 2019, a taxpayer can not contribute more than $19,000 to a 401(k). That limit increases annually and taxpayers over the age of 50 are allowed to contribute an additional $6,000 annually. The contribution limit does not include employer contributions. Many Americans are confused about 401k plans, so it’s important to do your research to fully understand how your 401k plan works.

Annuities

An annuity is a life insurance policy that works like an investment. Similar to a contract between an individual and a life insurance company, a policyholder pays a premium and the life insurance policy will promise to pay the policyholder a certain amount each month, usually starting at retirement and continuing until death. Policies are usually purchased with after-tax money but the earnings from the annuity are taxed at withdrawal.

There are two types of annuities, fixed annuities and variable annuities. Fixed annuities guarantee a specific interest rate. Variable annuities are more similar to mutual funds and invest in a pool of money invested in stocks, bonds, and cash but they guarantee income or withdrawal benefits.

Anyone can purchase an annuity, unlike a 401(k) that is usually purchased by a company. Payouts from an annuity are guaranteed for life and can not run out, unlike a 401(k) that will only pay out as much money as is in the account. While heirs can inherit a 401(k) annuity payments usually stop with the death of the policyholder, although there are some plans that make payments to beneficiaries.

Fees associated with annuities can be significantly higher than other investment accounts and policyholders may pay commission fees, benefit rider fees, and more. Similar to a 401(k) annuities have early withdrawal fees but unlike 401(k)s, annuities have no contribution limit and many people purchase them after maxing out their 401(k) contribution.

Mutual Funds

A mutual fund is a type of security comprised of money collected from many investors to invest in stocks, bonds, money markets, and other assets. Professional money managers operate mutual funds with a goal of producing capital gains or income for investors.

Similar to a variable annuity, a mutual fund also uses pools of money to invest in a variety of stocks, bonds, or cash. Mutual funds holders are taxed for dividends and are subject to capital gains whenever a position is sold, whereas annuities offer a form of protection because dividends issued within sub-accounts are not taxed.

Unlike annuities, which are regulated by state insurance commissioners, mutual funds are regulated through the Securities and Exchange Commission (SEC) and must provide transparency, liquidity, safety, and an audited track record.

Consider Investing Help From a Professional

401(k)s, annuities, and mutual funds are all part of a solid investment strategy and each can have a place in securing your financial future. Enlist the help of a professional financial advisor to understand the important differences between the three and create a financial plan that will carry you through retirement.

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