If you have a 401(k) planyou probably know that you can use it to invest in a wide variety of funds—target date fund, passively managed index funds and actively managed mutual fund. However, some plans also allow you to access other types of financial products, such as annuities.
An annuity is a contract between you and an insurance company in which you make a lump sum payment or series of payments and, in return, receive regular payments, starting immediately or at some point in the future.
Annuities can be a good way to fund some people’s retirement, but they’re not that common in 401(k) plans. Although becoming increasingly common, in 2020 only 16.3% of pension plan members are offered retirement income options. One reason for this: Employers ultimately have a responsibility to ensure they offer “prudent” investments through their 401(k) plans, and offering annuities involves the risk that an insurance company could go bankrupt. As a result, plan sponsors may fear being sued. The Every Community Establishment for Retirement Enhancement Act (SECURE) reduces this risk and makes annuities a safer option for employers, but they are still an unusual choice.
If your 401(k) offers annuities, however, they might be a good option for retirement, depending on your situation. In this article, we’ll look at the pros and cons of adding annuities to your 401(k) account.
Key points to remember
- If you want to purchase an annuity as part of your retirement portfolio, you may be able to do so through your 401(k). Some employers allow employees to purchase annuities through their 401(k) plans; Others don’t.
- If you can purchase an annuity this way, it may offer advantages. You may get a better rate than is available for annuities on the open market, and your employer may well have vetted the annuity provider to reduce your risk.
- On the other hand, since annuities offer the same tax benefits as 401(k) accounts, it’s often better to buy annuities with money that would otherwise be taxed, assuming you’ve had enough. outside of your 401(k) to afford it.
Types of annuities for your 401(k)
Before putting an annuity in your 401(k), it’s worth making sure you understand the different types that may be available to you. This is important because the options can be complex. Beyond a simple fixed immediate annuity, you may be able to purchase a much more complicated and expensive annuity variable annuityor a little less complicated and expensive indexed annuity.
Another popular choice is a Qualified Longevity Annuity Contract (QLAC). It’s an advanced type of life deferred annuity financed by an investment of one qualified pension schemelike a 401(k) or a individual retirement account (IRA). As of January 1, 2022, a person can use up to $145,000 from their retirement savings account to purchase a QLAC. The advantage of a QLAC is that the minimum required distributions are deferred tax.
Annuities can be a good choice for your retirement walletbut it depends on your situation and risk tolerance. It’s important to understand this before purchasing one, whether through your 401(k) account or otherwise. Lily our annuity guide Make sure it’s a good option for you before buying one, because withdrawing your money from an annuity after you’ve purchased it can be tricky and expensive.
Benefits of buying an annuity in your 401(k)
If you’ve decided that an annuity is right for you, you have several options for purchasing one. Here are the benefits of doing it through your 401(k):
- Potentially higher payouts. Your employer may have more leverage when it comes to negotiating annuity rates, so the money you receive for an annuity option in your 401(k) may be more than you can get. on the free market. This may not be the case, so be sure to check each option carefully.
- Gender neutral pricing. Annuity prices normally reflect life expectancy and women on average live longer. For annuities offered on the open market, this means that women can expect a lower monthly payment. In a 401(k), all participants should be offered the same prices and offers, making it a better offer for women (and, potentially, a worse offer for men).
- Peace of mind. The annuity provider has probably been carefully vetted by your employer, who has fiduciary responsibility for the security of your plan.
- Finally, you may have no choice but to go this route if you want to purchase an annuity. As annuities become an attractive option, many seniors are finding that the majority of their assets are tied up in their 401(k), making it the most convenient way to purchase an annuity without complex real estate refinancing (and potentially costly).
Disadvantages of buying an annuity in your 401(k)
As with any investment decision, purchasing an annuity through your 401(k) also has potential downsides. Some of them are the same whether you buy an annuity through your 401(k) or on the open market – annuities generally offer lower growth than actions Where exchange-traded funds (ETFs)and it can be difficult to withdraw money from an annuity while it is still in the accumulation phase.
However, perhaps the biggest disadvantage of purchasing an annuity through your 401(k) is that it reduces some of the fiscal advantages to have a 401(k) account. That’s because annuities have the same tax-deferral benefit as 401(k)s and it works the same way. You don’t pay taxes on the growth of an annuity — or money in a 401(k) — until you withdraw the money.
For this reason, it may not make sense to purchase an annuity in an account where you are already tax-deferred. If you can, you should use the money in a taxable account to purchase an annuity. However, many people don’t have the funds in a taxable account to purchase an annuity, so you may have no choice but to use your 401(k) account if you want an annuity.
Can I purchase an annuity for my 401(k)?
It depends on your employer. Some plan sponsors are hesitant to offer annuities as part of their 401(k) plans, while others are happy to do so.
What types of annuities can I buy for my 401(k)?
Again, this depends on your employer, but you may have several options. Beyond a simple fixed immediate annuity, you might be able to purchase a much more complicated and expensive variable annuity, and the slightly less complicated and expensive indexed annuity. Another popular choice is a qualified longevity annuity contract (QLAC), which has tax advantages.
Should I buy an annuity for my 401(k)?
It depends. First, you need to make sure an annuity makes sense for your retirement portfolio. Then look how you can buy one. Purchasing an annuity through your 401(k) can give you access to a better rate than on the open market; on the other hand, you will miss out on certain tax advantages.
If you want to purchase an annuity as part of your retirement portfolio, you may be able to do so through your 401(k). Some employers allow employees to purchase annuities through their 401(k) plans, but others do not.
If you can purchase an annuity this way, it may offer advantages. You may get a better rate than is available for annuities on the open market, and your employer may well have vetted the annuity provider to reduce your risk. On the other hand, since annuities offer the same tax benefits as 401(k) accounts, it’s often better to buy annuities with money that would otherwise be taxed, assuming you have enough. outside of your 401(k) to allow you to do so.