Annuity vs. 401(k): Which Is Better for Retirement?

Choosing the right way to save for retirement based on your personal needs is easier said than done. There are many options available, with annuities and 401(k) plans being some of the most prominent. While these two popular retirement savings vehicles are similar in some ways, they also have important differences, as well as times you can best use them. Below, we detail what should make or break your annuity vs. 401(k) decision. If you have questions about your specific situation, consider working with a financial advisor.

What Is a 401(k)?

A 401(k) is a tax-deferred retirement account you can often get through your employer. You contribute money to it, often as a regular deduction from your paycheck. You don’t have to pay taxes on earnings contributed to a traditional 401(k) at the time you make them. Roth 401(k)s, however, are funded with after-tax money.

The money in your 401(k) is invested in mutual funds, exchange-traded funds (ETFs) or other investments of your choosing. When it comes time to retire, you can withdraw funds from the account to cover your expenses. You don’t have to pay taxes on the money until you withdraw it. The funds in a Roth 401(k) are, again, exempt, as you’ve already paid taxes on your contributions.

What Is an Annuity?

An annuity is a financial product offered by life insurance companies. It functions as both an insurance policy and an investment. In simple terms, it’s a contract where you pay the insurance company either a lump sum or regular premiums, and in return, they agree to provide you with periodic payments, typically starting at retirement and continuing for the rest of your life.

You can fund an annuity with pretax money, such as through a 401(k), or with after-tax dollars. If you use after-tax money, the earnings from the annuity are taxable when withdrawn, but the initial amount you paid is not, as taxes were already applied at the time of contribution (similar to a Roth contribution). On the other hand, if the annuity is funded with pretax money, both the original contribution and the earnings are taxable upon withdrawal.

Major Differences Between an Annuity vs. 401(k)

A 401(k) is a tax-deferred retirement account you can often get through your employer.

Choosing between an annuity and a 401(k) depends on your retirement goals, access to employer-sponsored plans and how much flexibility you want. While both options can help fund retirement, they differ in accessibility, fees, flexibility and treatment upon death.

Accessibility and Eligibility

401(k) plans are employer-sponsored retirement accounts, meaning you can only contribute if your employer offers one. Self-employed individuals can establish a solo 401(k), but employees without access to a workplace plan cannot use a 401(k). By contrast, anyone can purchase an annuity through an insurance company, regardless of employer status.

Fees and Costs

401(k)s typically come with lower and more transparent fees. You can review your plan’s fee structure by requesting information from your plan administrator. Annuities, however, often carry significantly higher and more complex costs. These may include:

Sales commissions
Administrative fees
Rider fees for added features like guaranteed lifetime income or death benefits

Early Withdrawal Penalties

Both 401(k)s and annuities impose penalties for early withdrawals. With a 401(k), taking funds out before age 59.5 typically results in a 10% penalty, along with income taxes. Annuities have their own early withdrawal penalties, known as surrender charges, which can be steep in the first few years, but usually phase out after five to seven years.

Loans and Liquidity

401(k) plans offer the flexibility to borrow against your balance, depending on your plan’s rules. Annuities do not offer loan provisions, meaning your funds are locked in with more limited liquidity.

Payout Structure and Inflation Risk

Annuities are often structured to provide fixed, regular payments for life, which can offer peace of mind but may not keep pace with inflation. Some annuities offer inflation-adjusted payments, but these typically come at a higher cost. A 401(k), on the other hand, allows more control over how and when you withdraw your money in retirement, potentially providing better inflation flexibility through diversified investments.

Inheritance and Beneficiaries

401(k) accounts can be inherited by beneficiaries and rolled over into inherited IRAs. Annuities, by contrast, often terminate payments at the time of the annuitant’s death. However, some annuities offer death benefit riders that continue payments or provide a lump sum to designated heirs, though these riders come at an additional cost.

How to Choose Between an Annuity vs. a 401(k)

Both annuities and 401(k) plans offer valuable retirement planning benefits, such as tax-deferred growth and the potential to pass down assets outside of probate. But choosing between the two — or combining them — depends on your personal financial situation, retirement timeline and need for income security.

Why Choose a 401(k)?

A 401(k) is typically the first retirement savings vehicle for anyone with access to an employer-sponsored plan. Contributions reduce your taxable income (unless it’s a Roth 401(k)), and employer matching makes this option even more appealing. If you’re still working and haven’t yet maxed out your 401(k) contribution limits, it’s generally wise to prioritize this account. The investment flexibility and potential for market growth make it ideal for long-term savers who want to build a retirement nest egg with room to grow.

When to Consider an Annuity

Annuities may be a better fit later in life, especially as you transition from asset accumulation to income generation. Some retirees choose to purchase an annuity using a portion of their 401(k) balance, creating a guaranteed income stream that can supplement Social Security. This approach helps reduce sequence-of-returns risk and provides peace of mind in market downturns.

Research supports this approach: A study published by the National Bureau of Economic Research found that retirees with more of their wealth in guaranteed income sources tend to spend more comfortably and confidently in retirement than those relying heavily on investments.

Risks and Trade-Offs

Annuities, however, come with limitations. Fixed annuity payments may lose purchasing power over time due to inflation, unless you pay extra for an inflation-adjusted rider. Meanwhile, stock investments historically offer higher long-term returns, Goldman Sachs reports a 9.2% average annual return over the last 140 years for equities, highlighting the opportunity cost of moving too much of your portfolio into fixed income products.

Combine for a Balanced Approach

For many retirees, a blended strategy works best. Using a portion of your 401(k) to purchase an annuity can offer income stability, while keeping the rest invested can help your portfolio continue growing. This mix can balance market risk with income certainty, especially valuable in the early years of retirement.

A financial advisor can help tailor a strategy based on your timeline, income needs and risk tolerance — helping you make the most of both vehicles.

Annuities vs. 401(k)s – Making Withdrawals

Another big difference is that an annuity offers a guaranteed payment for as long as you live. That means, at least with most annuities, you won’t run out of money. A 401(k), on the other hand, can only give you as much money as you have deposited into it, plus the investment earnings.

If the market goes down, annuity payments keep coming. The same can’t be said of a 401(k), however, which is subject to market cycles. This also means if your 401(k) investment choices do well, you could have more money. With an annuity, you don’t benefit if the market is up, unless you take your chances with a variable annuity.

There are also limits on the amount you can contribute to a 401(k). For the 2025 tax year, the contribution limit amount is $23,500. This typically increases annually to account for inflation, and is up from $23,000 for the 2024 tax year.

If you’re 50 or older, you can put in another $7,500 as a “catch-up contribution” for both tax years 2024 and 2025. If you’re in the 60 to 63 age range, however, that catch-up contribution is increased to $11,250 instead of $7,500 for tax year 2025, thanks to a change made in the SECURE 2.0 Act.

Your employer may match all or part of your contributions, as well, which will further increase the amount going into your 401(k).

With annuities, there are no such limits, so some people buy them with one-time payments of sometimes $1 million or more. If you’ve maxed out your 401(k) contribution and want to sock away more, an annuity will let you do that.

Bottom Line

A financial advisor can help you decide if an annuity vs. 401(k) is right for you.

Choosing between an annuity and investing in a 401(k) is going to depend on a number of factors, from how much you can save to how much you need to earn during your retirement years. If you go through the pros and cons of each and still aren’t sure, consider working with a professional financial advisor to help you decide the best path forward to the retirement of your dreams.

Tips to Plan for Your Retirement

Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area. You can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
During the retirement planning process, it’s important to think about the retirement tax laws of the state you want to retire in. By minimizing your retirement tax burden, you can maximize the value of your savings in retirement.