401(k)s are tax-advantaged workplace retirement savings plans.
Annuities offer guaranteed lifetime income—and some can invest and grow.
More employers are offering annuities in their 401(k) plans.

At some point in your career, you’ll likely want to retire. There are many different options for stashing retirement savings away so that you’ll be able to afford it—and for providing income throughout your golden years. But the types of retirement vehicles you choose can affect how easy it is to access your money, and how much you’ll owe in taxes on it.

Two common tools in the retirement box are 401(k) plans and annuities. They can both be useful as you plan for your future, but there are important differences between them.

 

 

What’s a 401(k), and how does it work?

A 401(k) is a type of “defined contribution” (DC) retirement plan. Unlike traditional “defined benefit” (DB) pensions, with DC plans employees or organization members are responsible for funding their own accounts. (Employers may contribute to their employees’ accounts too.) With a 401(k), you can have a portion of your wages deducted from your paycheck and invested in a range of mutual funds and sometimes other investments. Other defined contribution plans include 403(b)s (available to some public school and hospital employees) and 457(b)s (for some government and nonprofit workers).

401(k)s and similar plans offer important tax advantages: In a traditional 401(k), you contribute pretax dollars, and the account can grow tax deferred until you withdraw from it, typically in retirement. At that point, you’ll owe regular income tax at your then-current rate.

You may also be able to choose a Roth 401(k): You contribute money that’s already been taxed, but distributions are tax free if you hold the account for at least five years and meet other criteria.

  • Investment types: A 401(k) plan allows you to choose your investments. Typically, you can pick from a menu of mutual funds that invest in stocks or bonds, “target-date” funds that hold a broad range of investments and grow more conservative over time, and sometimes funds that hold shares of the employer’s stock.
  • Contribution limits: In 2025, the IRS says you can contribute up to $23,500 to your 401(k) ($31,000 if you’ll be at least age 50 by Dec. 31). There's also a combined limit on how much an employee and employer can contribute each year. Thanks to the SECURE 2.0 Act of 2022, you’ll be able to save even more if you’re between ages 60 and 63. Beginning in 2025, if the plan allows it, savers in this age range can put away an additional $11,250, or over 50% over the regular catch-up limit (whichever is higher).
  • Vesting: This refers to how much of the account you own. Your contributions (and their earnings) are always yours to keep. But your employer may have a vesting schedule for their contributions (and related earnings) to encourage you to stay at the company. For example, you might become fully vested after you’ve been employed for three years—after that, you’d own the entire account even if you leave your job. Or, you might vest incrementally—say, 25% after one year, 50% after two years and so on.
  • Portability: When you leave a company, you’ll typically have four options: keep your money in the employer’s plan; roll some or all of your account over to your new employer’s 401(k) or to your own individual retirement account (IRA); or cash it out (this will trigger income taxes and a possible early-withdrawal penalty, so do it only if you absolutely need the money).
  • Required minimum distributions (RMDs): Traditional IRAs have federally required minimum amounts you must withdraw each year, starting at age 73. However, SECURE 2.0 has eliminated RMDs for Roth 401(k) effective from 2024Opens in a new window.

401(k) advantages

There are many benefits to a 401(k).

  • There may be a match. Some employers encourage you to invest in your future by matching a portion of what you put in your account. That’s like getting free money, so you should consider saving at least enough to earn the full match.
  • It’s automatic. Once you set up contributions from your payroll, investing becomes routine and easier to fit in your budget. (If you don’t see the money, you’re less likely to miss it.) The same goes for automatic contribution increases—maybe by one or two percentage points a year—a (relatively) painless way to help your account grow.
  • Your investment might grow. With multiple investment options, you can often choose how much risk you want to take with your money (or, if target-date funds are available, choose the one that best matches your situation). The money can compound and grow over time—even more so with regular investing and employer matching.
  • You get tax breaks. When you contribute to a traditional 401(k), you may pay less in taxes during your working years. That’s because the money you put in comes from your paycheck before taxes are taken out. This lowers your taxable income (and also means that every dollar you contribute costs less than a dollar in take-home pay). With a Roth 401(k), you get the tax benefit down the road: You contribute after-tax dollars, but the account can grow tax free, and you won’t owe taxes when you withdraw if you meet certain criteria.

401(k) disadvantages

There can also be some negatives.

  • Limited investment options. Your choices include only what’s on your employer’s or organization’s menu.
  • You don’t have full control over when to take money out. Besides taxes and possible penalties on withdrawals before age 59½, you’ll face required minimum distributions (RMDs) later—you have to withdraw a certain amount each year starting at age 73 or retirement. That may not work well with your needs or with the value of your investments.
  • You might owe more tax than you expect. Usually, people assume they’ll be in a lower tax bracket—and face lower income taxes—after they retire and start withdrawing from their accounts. But that’s not always the case, and you may owe more than you anticipated.

What's an annuity, and how does it work?

An annuity is an insurance product that provides regular income payments for life. Typically purchased through an insurance company, it can help protect and, depending on the kind of annuity, even grow your retirement income—with taxes deferred until you start taking payments.

Some annuities can provide benefits right away. For instance, if you have a lump sum of money, you can buy an “immediate” annuity and start receiving payments (with interest) at once.

Or, an annuity can be deferred: You make either a lump-sum payment or multiple payments first, then start to receive income installments later.

Types of annuities

You can also categorize annuities by how the payments are determined.

  • Fixed: These annuities guarantee payments at a specific rate and amount, no matter what happens in the market.
  • Variable: Variable annuities are tied to the ups and downs of the stock market, and the income you receive can fluctuate based on market conditions. These annuities involve more risk but have higher potential for growth.
  • Indexed: These annuities pay interest based on the performance of an index—an often large group of stocks that track a portion of the market (like the S&P 500® index of large companies listed on U.S. stock exchanges) rather than the overall market itself.

Annuity advantages

Annuities provide important advantages for retirement:

  • They ensure steady income. You get a source of regular, reliable income.
  • You control the terms. If you’re married, you can usually choose to take full payments for the rest of your life or partial payments that will continue to go to your spouse if you should die first. Also, you decide how much risk to take. You can choose a lower-risk fixed annuity (so you know exactly how much you’ll receive), or a variable annuity (which rises and falls with the market—it involves more risk, but also potentially more growth).
  • They can offer some growth potential. Annuities can provide income for life, but you still can seek more growth by selecting a more aggressive variable annuity.
  • There’s no limit. You can put as much money as you like in an annuity. For example, you might choose to guarantee some income with an annuity while keeping the rest of your retirement money in an account that can continue to grow.

Annuity disadvantages

Annuities also have their potential downsides.

  • You might make more money investing. With annuities, you’re often trading hopes of growth—and beating inflation—for the security of guaranteed payments.
  • The provider could fail. Like any insurance product, annuity guarantees are only as strong as the company that provides them.
  • Typically, they’re hard to get out of. Once you've bought an annuity, you’ll likely be committed to it and unable to get your money back except according to the terms of your contract.
  • Variable annuities can be expensive. While these annuities usually offer the most potential for growth, they also tend to come with multiple fees.

What to consider when you choose

In some ways, annuities and workplace retirement accounts are two sides of the same coin. A defined contribution plan like a 401(k) is considered a good way to accumulate (save) retirement funds even if you’re starting from scratch. By contrast, annuities are for the decumulation (withdrawal) phase of retirement; because they typically require a large initial amount to provide the income you’ll need, they’re considered best for preretirees (typically over age 50) who’ve already built up a nest egg and are concerned about having a reliable retirement income stream in addition to Social Security.

But that’s a conventional way of thinking about it, and it may not apply to you. There are reasons to choose one over the other, and there are times to consider holding multiple retirement vehicles.

If an employer offers a 401(k) (or similar plan), it’s a smart idea to take advantage of it. Besides the tax breaks, you can usually invest more each year than you can with an IRA. And if your employer matches contributions, think about saving at least enough to take full advantage of that money.

But not all employers offer a 401(k). And if you work part time, you might not have access to a workplace plan at all. In that case, you might want to consider purchasing an annuity, either with a lump sum (if you have it) or with regular payments. Or if you’re approaching retirement and are concerned about stock market risk, putting some of your money in an annuity may be a safer choice.

It’s also important to consider how much income you want in retirement. Some annuities guarantee a set payout at regular intervals, while a 401(k)’s return may depend on market factors—and you may not be able to control your withdrawal schedule. And if you start contributing to a 401(k) later in life, your money has less time to grow.

Can you roll over an annuity into a 401(k)?

The short answer—Yes, but it’s complicated.

You can sometimes roll an annuity into a 401(k) plan if the annuity is already held in a “qualified” retirement account like an IRA. However, both the 401(k) and annuity provider must have rules that allow this.

The SECURE 2.0 Act of 2022 made it easier for employers to add annuities to their 401(k) investment options—so that may be available to you if it’s not already. Even so, while annuities are pretty common in 403(b) plans, less than one in five 401(k)s currently offer them.*

 

You might want to evaluate your retirement saving and income options with a trusted financial professional who can help you choose what’s best for your situation. There’s no reason to stick with only one vehicle to provide income during retirement, and with changes like those in the SECURE 2.0 Act, it’s worth reviewing your choices. Given your financial goals, sometimes having multiple retirement accounts and products like annuities are the best ways to go.

Of course, you should consult your tax and legal advisors regarding your circumstances.

 

Written by Deborah Abrams Kaplan

Deborah Abrams Kaplan covers personal finance and insurance for publications and brands. She previously investigated professional liability claims for an insurance company.

Footnote

*Prudential does not currently offer these options.


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