What's going on with your money: Income Difference Between a 401k and an Annuity

The warm summer air inspires many baby boomers to put in their retirement paperwork. Sadly, many of those same baby boomers have never sat down with a professional to discuss their income needs in retirement let alone how long their income will last. Well, I'm here to provide you with some information to help you better understand the difference between an income from a 401k compared to an annuity.

First, allow me to start off with the basic definition of a 401k and an annuity.........in plain English. A 401k is an employer sponsored plan contributed to by the employee and employer (only if they offer a match). A 401k is typically contributed to with pre-tax dollars from an employee's paycheck and taxes are paid upon taking a distribution (in retirement, it's your income). On the other hand, an annuity is a contract between an insurance company and an insured (you) where you can either make a lump sum contribution into or make monthly contributions (like a 401k) in exchange for a monthly income in retirement. Examples of an annuity are pensions, social security, and lottery payouts.

In my example below, I will give you Retiree A and Retiree B. Both are 65 years old and both will have the same account value upon retirement and both will take $10k per year. Retiree A will begin taking an annual income distribution from his 401k and Retiree B will begin taking an annual income distribution from his annuity (401k rolled over to annuity at retirement).

The table above illustrates how Retiree A will run out of money after year 15 (age 80), whereas Retiree B will continue to receive an income even after his annuity account value has reached a value of $0. Remember when I provided the definition and example of an annuity? Retiree B will NEVER run out of money in retirement because he has a contract with the insurance company and the insurance company assumes all risk if he outlives his money.

That, my friends, is the difference. Will you or your loved ones run out of money in retirement or will it last a lifetime?

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