When 401(k)s began replacing private employer pensions decades ago, employees lost a crucial piece of their retirement plan: a guaranteed lifetime income stream. Unlike pensions, 401(k)s place the risk of outliving savings squarely on the retiree's shoulders.
Buying Annuities in Your 401(k)
As part of the Setting Every Community Up for Retirement Enhancement Act, Congress encouraged 401(k) plans to offer annuities. "An annuity is insurance for your lifetime income, sort of like your own personal pension," says Philip Maffei II, TIAA's managing director of corporate retirement income products.
If you're near retirement and want an annuity, buying one through a 401(k) has advantages, but variety isn't one of them. Most 401(k)s offer only an immediate fixed annuity, which starts paying income right away for the rest of your life. If you want another type, like a variable annuity with market exposure for potentially higher growth or a deferred annuity, you'll likely need to buy it outside the plan. Here's what else you should consider.
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The Heavy Lifting Has Been Done
Employers have been reluctant to include annuities in 401(k)s, fearing they would be held liable in the rare instances that an annuity company goes bankrupt. The SECURE Act protects plan sponsors from liability provided they follow federal guidelines for selecting viable insurers. For example, an employer must consider the annuity company's credit rating, financial health, and the fees relative to the benefits paid to employees. Companies must have met the state's requirements, including maintaining enough reserves, for the past seven years. Those protections also help employees. "You've got a sophisticated expert reviewing the products first," says Sri Reddy, senior vice president of retirement income at Principal Financial Group.
Group Pricing May Be a Better Deal
Although the plan is not required to go with the cheapest provider, "in general, large group pricing leads to a better deal than the individual markets," says Maffei. For women, there's an additional advantage. "Annuities in a 401(k) must use unisex pricing," says Wade Pfau, a professor of retirement income at The American College of Financial Services. In the individual market, companies can charge different rates based on gender. "This is good for women inside the plan as they tend to live longer. It's not as good for men, relatively speaking, who may find a better option outside the plan," says Pfau.
You Can Keep Your Annuity Even If Your Employer Doesn't
In the past, if your employer switched annuity providers, you may have had to switch too, losing your existing benefits and guaranteed income stream. Now, when the employer changes providers, you can keep the annuity and "roll it over to an IRA to preserve your benefits without any incremental fees," says Reddy.
You'll Have a Better Idea of Your Income
Whether they offer annuities or not, plan sponsors are required to estimate how much guaranteed lifetime income your account balance could potentially generate if you bought an annuity, helping you determine if one is worthwhile. You should get an estimate for your life and a joint life estimate if you're married.
You May Be Able to Transfer Funds
One obstacle to buying an annuity in a 401(k) is that your retirement savings may be scattered in different accounts. "Most employees move pockets of savings into an IRA as they change jobs," says Reddy. "They might not have enough in their current 401(k) to properly fund an annuity." Some companies may allow employees to transfer other retirement funds into the 401(k) using a rollover, but retired employees won't have this option, even if they still have money in the 401(k).
The Clock Is Ticking If You Have Second Thoughts
Unless the plan offers something other than an immediate annuity, you are locked in once you buy it, though Reddy says you will have at least a 30-day free look period during which you can back out of the contract. "Once you begin to receive lifetime income payments, you cannot change your mind," Maffei says.
The Income Is Taxed in Full
Because you used pre-tax dollars to buy the 401(k) annuity, 100% of that income will be taxable. When you buy an annuity outside of the plan using after-tax dollars, part of your payments are tax-free as the company returns your original contribution.
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FAQs
You probably also know that within your 401(k), you have a choice of investments. Typically, you can invest your money in target-date funds, passively managed index funds, and actively managed mutual funds. Some plans allow you to purchase annuities, which are another option for funding retirement.
Is an annuity considered a 401k? ›
Although both are financial tools that can help you save for retirement and allow for tax-deferred growth, the two are very different. At the most basic level, a 401(k) is a type of retirement account – a container if you will – that holds different financial products, while an annuity is itself a financial product.
What does annuity fall under? ›
An annuity is a written contract typically between you and a life insurance company in which the insurance company makes a series of regularly spaced payments to you in return for a premium or premiums you have paid. An annuity is not life insurance. A life insurance policy provides benefits to your family if you die.
What type of account is an annuity considered? ›
An annuity is an insurance product that can help guarantee you'll never run out of retirement savings. Some parts of deferred annuities work in ways similar to common retirement accounts—like growing with the market in the case of a variable annuity and having some tax advantages—but they are a product, not an account.
What falls under 401k? ›
The Bottom Line. A 401(k) plan is a workplace retirement plan that allows you to make annual contributions up to a specific limit and invest that money for your later years after your working days are over. There are two types of 401(k) plans: traditional or Roth.
Should an annuity be part of a retirement plan? ›
Like any investment, an annuity should be incorporated into a holistic retirement plan, and “should never dominate a portfolio,” Goetsch says. But as a part of your overall plan, annuities can play an important role in helping you accomplish your financial goals and plan for a secure retirement.
Who should not buy an annuity? ›
So, if you have experience and success managing your funds on your own and can convert your assets into an income, there is no reason to buy an annuity. 2. Don't buy an annuity if you're sure you have enough money to meet your income needs during retirement (no matter how long you may live).
How much does a $50,000 annuity pay per month? ›
Payments You Might Receive From a $50,000 Annuity
A straight fixed annuity is the easiest type of annuity to calculate a payment from. This is because fixed annuities work like bonds. If you use $50,000 to buy a fixed annuity paying 5% per year, for example, you'll earn $2,500 annually or about $208.33 per month.
How much does a $100,000 annuity pay per month? ›
A $100,000 immediate income annuity purchased at age 65 could provide around $614 per month. With a 5% interest rate and a 10-year payout period, the same annuity might pay approximately $1,055 monthly. At age 70, a similar annuity could offer a lifetime payout of around $613 per month.
Does an annuity count as income? ›
Because annuities grow tax-deferred, you do not owe income taxes until you withdraw money or begin receiving payments. Upon withdrawal, the money will be taxed as income if you purchased the annuity with pre-tax funds. You'll only owe taxes on the annuity's gains if it was purchased with post-tax dollars.
Closing or cashing out an annuity altogether—simply pulling out all your money and shutting down the contract—is an option if you need all of the funds. However, this process may also come with surrender charges, tax implications and the 10% federal tax penalty.
How safe are annuities? ›
Yes, annuities are a safe addition to a retirement plan. They're a safer income source than options like stocks and bonds due to their market-proof returns. Annuities carry the risk of early death, but certain riders can protect heirs from income loss if the annuitant passes away prematurely.
Has anyone ever lost money in a fixed annuity? ›
Insurance companies rarely fail, but should it happen, it is possible to miss payouts for a while or lose a portion of your purchase. It's important to remember that any guarantees are related only to fixed annuities and are backed by the claims paying ability of the issuer.
What is not a 401k but a? ›
IRA. You've probably heard of IRAs, short for individual retirement arrangements, which are also commonly called individual retirement accounts. Anyone with earned income (including those who do not work themselves but have a working spouse) can open an IRA. There are a couple different options, Roth and traditional.
What investments are in a 401k? ›
The employee can choose one or several funds to invest in. Most of the options are mutual funds, and they may include index funds, large-cap and small-cap funds, foreign funds, real estate funds, and bond funds. They usually range from aggressive growth funds to conservative income funds.
What makes up a 401k? ›
With a 401(k), an employee sets a percentage of their income to be automatically taken out of each paycheck and invested in their account. Participants can choose how to allocate their funds among the investment choices offered by the plan, which usually include a variety of mutual funds.
Is annuity income considered retirement income? ›
If you receive retirement benefits in the form of pension or annuity payments from a qualified employer retirement plan, all or some portion of the amounts you receive may be taxable unless the payment is a qualified distribution from a designated Roth account.
Is An annuity a retirement or investment? ›
In fact, annuities are not investments, although people often think of them that way. They are insurance products that can guarantee you will never outlive your retirement savings, and they can be good savings tools.
