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Annuity vs 401k – Income as the Outcome

By Cathy DeWitt Dunn

Annuity vs 401kRelying on a 401(k) as a main source of retirement income is sort of like buying a Smart Car to pull your boat. When planning for retirement, success depends on choosing the right vehicle for the job. It’s important to understand how an annuity vs 401k works if income is your desired outcome.

Annuity vs 401(k) – What’s the Difference?

So what makes the 401(k) the wrong vehicle for producing income? Simply put, 401(k) plans were created to be supplemental savings vehicles, not income generators. Let’s look at the annuity vs 401(k) plan as a retirement income stream and see who comes out on top. Back in 1978 when 401(k) plans were created, most employers sponsored employee pension plans. The objective of these defined benefit plans was to provide a set amount of retirement income for the lifetime of the employee. Between pensions and Social Security, most Americans had plenty of guaranteed lifetime income to provide for their needs.

In this context it is easy to understand that defined contribution plans like 401(k)s and IRAs were meant to offer a means of saving extra money for retirement while taking advantage of tax deferral. Now that most employers have eliminated pension plans, Americans are left to figure out how to fill the retirement income void. Most simply don’t understand that their 401(k) is the wrong vehicle for the job.

Income and the Stock Market

When we retire, we need to know we will have income to rely on for our daily needs for as long as we live. The trouble is we don’t know how long that will be. Walking the tightrope of withdrawing as much as we need, but not enough to cause us to run out of money decades later, is a difficult undertaking. When you add losses due to stock market downturns into the mix, it becomes a truly treacherous situation.

We need guaranteed income for our lifetime, but fewer than 20% of 401(k)s offer a lifetime income option. So where is a retiree to turn?

Fixed Index Annuities

Rolling a 401(k)’s balance over to a Fixed Index Annuity styled as an IRA is a non-taxable transaction that protects you from two major retirement dangers: market risk and longevity risk.

First, FIAs provide a safe haven from stock market downturns by guaranteeing principal and annual gains against loss. This means no matter what happens in the stock market, an FIA’s value will only decrease if income is being drawn from it. The owners of FIAs never have to recover from stock market losses or worry that a market crash will consume years of their retirement income.

The best advantage of Fixed Index Annuities is their ability to provide guaranteed lifetime income. No matter how long you live, your FIA plan will continue to pay you a contractually guaranteed income. Some plans even offer the ability to continue to earn interest credits while you are drawing a retirement income stream. This allows your income the ability to grow with inflation over the decades you’ll spend in retirement.

With pension plans becoming a rarity and lifespans getting longer and longer, it’s time for Americans to start looking at retirement differently. Many people are selling themselves short when it comes to retirement income because they are asking their 401(k) to do the job of an annuity. Get to know more about Fixed Index Annuities and how they create lifetime income by watching our educational video series.

2019 401(k) Changes – Employee Contributions

To begin, the employee contribution limits for those younger than 50 for a 401(k) increased from $18,500 in 2018 to $19,000 for the tax year of 2019. This $500 increase may not seem like much, but added up over time it can make a significant impact on retirement. In 2012, the contribution limit was $16,500, so we have seen a steady increase over the years. For those 50 or older, the contribution limit increased by $500, to total $25,000 in 2019. As discussed by The Balance, these increase are tied to the CPI (Consumer Price Index), which measures inflation, and happen only in $500 increments.

saving for a 401(k)

However, this does not mean an increase will be warranted each year – if the CPI does not go up, then it results in no change to the contribution limit. With these contribution limits in mind, we recommend having several sources of income rather than relying solely on one retirement fund such as a 401(k). This makes sure that your money is protected from any downward market turns or unforeseeable circumstances.

2019 401(k) Changes – Employer Matching

Another change we saw to 401(k)s in 2019 was with employer matching limits. This year, they increased by $1,000 from 2018’s limits, making the limit for those under 50 for combined contributions from employee AND employer to $56,000. But, note that this does not include any funds contributed under the catch-up provision; the maximum combined amount with this provision for those older than 50 is now $62,000.

Finally, the definition of highly compensated employees (HCE’s) changed, but still varies from employer to employer. The compensation for an HCE rose from $120,000 from 2015-2018 to $125,000 for 2019. This $5,000 increase isn’t the only change, though. You could be considered an HCE if you own more than 5% of the business during any time of the tax year in question. To learn more details about these changes, check out The Motley Fool, the IRS, or U.S. News.

Annuity product guarantees rely on the financial strength and claims-paying ability of the issuing insurer.

Related Articles from DeWitt & Dunn Financial Services and Annuity Watch USA


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