It’s important for everyone to plan for retirement, no matter their age. Professionals in the insurance world, like yourself, know this all too well.
You may also be familiar with some of the ways to secure funds for retirement, namely, 401(k)s and annuities.
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On the surface, these methods of investment may seem quite similar and, in some respects, they are. However, there are reasons why you might recommend one over the other.
Below, we examine the differences between these options and consider how you can help your clients make the most of their investments!
What Is an Annuity?
Annuities are an investment product purchased from an insurance company. There are different kinds of annuities to choose from, the most notable types of annuities being variable, fixed, and indexed. When an annuity is purchased, the policyholder makes premium payments to the insurance company and then what happens with that money depends on whether the annuity is fixed or variable.
During the accumulation period for a fixed annuity, the premiums paid by the insured earn a rate of interest set by the insurance company. For variable annuities, the insurance company puts the insured’s premium payments, minus any fees, into a separate account. Then the insured decides how the insurance company invests those premiums depending on the level of risk desired.
Starting immediately after the purchase of an annuity or at a future date, the policyholder’s money is paid back to them in addition to any interest or investment income gains.
Money from an annuity is paid back to the insured in addition to any investment income gains.
People, typically between age 45 to 75, buy this product to help manage their income during retirement, since they will no longer receive a salary. In addition to providing either a guaranteed lump-sum or series of payments, annuities offer tax-deferred growth and death benefits.
What Is a 401(k)?
In contrast, a 401(k) plan is a retirement savings option offered by some employers. Employees can choose to contribute a designated percentage of their wages to their 401(k) each pay. In many cases, the employer will also match a portion or all of the employee’s investment. These plans are designed to grow steadily over time, with the money being invested in a selection of index, mutual, or exchange-traded funds. Additionally, the investment earnings are tax-deferred and only taxed once money is withdrawn.
Note: An alternative type of 401(k), a Roth 401(k), differs from a traditional 401(k), in that it’s funded with after-tax money, and not taxed when withdrawn at retirement age.
Employees can choose to contribute a designated portion of their wages to their 401(k) each pay.
How Are Annuities and 401(k)s Different Investments?
Even though both annuities and 401(k)s can provide tax-deferred income during retirement and earn income through investments, each have unique characteristics that can make them right or wrong person to person. These are some of the differences your clients might be most interested to know about!
Many annuities can provide payments for the rest of a person’s lifetime, and some can even continue to pay beneficiaries after the insured has passed away. Also, many annuity types are not subject to losses in the market because the income is guaranteed by the contract with the insurance provider.
The exceptions to potential market loss are indexed and variable annuities since both pay a rate of interest based on the performance of specific market index or mutual funds. However, indexed annuities do still offer a guaranteed minimum interest payment.
Many annuities can provide payments for the rest of a person’s lifetime.
On the other hand, 401(k)s typically have no guarantee of lifetime withdrawal options. Additionally, because they are made up of different financial products such as stocks, bonds, mutual funds, and money market funds, the income is impacted by fluctuations within the market resulting in both possible returns and losses.
There’s no limit to the amount of money someone can put into an annuity, but there are annual 401(k) contribution limits. For 2023, the individual limit is $22,500 (or $30,000 for those 50 or older), and the combined employer and employee contribution limit is $66,000 (or $73,500 for those 50 or older). On the bright side, these annual limits are relatively high, especially for those nearing retirement sooner, but for clients who are looking to invest more, this is an important difference to note.
The amount an individual invests in an annuity depends on the type selected and their specific investment goals. A Flexible Deferred annuity can be purchased for as little as $500 to $1,000 with continued premium payments. Typically, a Fixed Annuity can be purchased for an initial investment of $2,500 or more.
Employers can choose to match a portion of their employees’ 401(k) contributions. Unfortunately, this is not the case for annuities. The money someone pays for an annuity is all from their own pocket. This detail is definitely a perk of having a 401(k).
Employers can choose to match a portion of their employees’ 401(k) contributions.
Another employer-based benefit of 401(k)s is profit sharing. This is a pre-tax contribution employers can deposit into their employees’ retirement accounts. As an end-of-the-year bonus, it’s possible that a profit-sharing contribution can be worth more to employees than a similarly sized direct bonus payment. Since these contributions are tax-deductible for employers, it’s a win-win advantage for both parties.
When Should You Recommend an Annuity or 401(k) Plan?
The decision to recommend an annuity or 401(k) will come down to each client’s specific investments goals. If your client is looking to work longer and wants to steadily grow money for retirement over time, then a 401(k) will most likely be the right fit for them. But if a client wants to retire relatively soon and has savings they can comfortably invest into a guaranteed income stream or lump sum, an annuity will likely nicely meet their needs. It’s important to get to know your clients and ask them questions about their finances and goals. Doing so will put you in the right direction to present a product or group of products that can help them live their lives to the fullest!
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It’s important to note that people can invest in both an annuity and 401(k). A combination of these products can be the best of both worlds for some clients! Logically, you may want clients to choose an annuity because it comes with a commission for you, but as always, it’s imperative to educate your clients on all of their options. Doing so will leave you with happy clients and a big book of business to show for it!
Still have questions about annuities or you want to start selling them? Schedule a call today to speak with one of our More than Medicare sales specialists! If you’re not partnered with Ritter yet, sign up for free today so you can benefit from everything we have to offer.