Annuity vs. 401(k) vs. IRA: Comparing Retirement Income Options

When planning for retirement income, three tools come up more than any others: annuities, 401(k) plans, and individual retirement accounts (IRAs). Each one offers tax-deferred growth, but they differ in contribution limits, withdrawal rules, tax treatment, and the type of income they provide. Understanding how these three options work individually and together is one of the most important steps you can take toward building reliable retirement income.

There is no single best choice. Each vehicle has strengths that fill a different gap in your retirement plan. A 401(k) is built for employer-sponsored savings with matching contributions. An IRA gives you additional tax-advantaged savings with more investment flexibility. An annuity provides something neither account can: a guaranteed income stream that can last for the rest of your life. This guide walks through how each one works, compares them side by side, and explains how to combine all three into a cohesive retirement strategy.

How a 401(k) Works

A 401(k) is an employer-sponsored retirement savings plan. You contribute a portion of your paycheck before taxes are taken out, which lowers your taxable income for the year. Your employer may match a portion of your contributions, which is essentially free money added to your retirement savings. For 2026, the IRS allows employees to contribute up to $24,500 per year to a 401(k). If you are age 50 or older, you can contribute an additional $7,500 in catch-up contributions, bringing your total employee contribution limit to $32,000.

The money in your 401(k) grows tax-deferred, meaning you do not pay taxes on investment gains, dividends, or interest until you withdraw the funds. When you take withdrawals in retirement, each dollar is taxed as ordinary income. If you withdraw money before age 59 and a half, you will owe a 10 percent early withdrawal penalty on top of regular income taxes, with limited exceptions.

Investment options within a 401(k) are selected by your employer and typically include a menu of mutual funds, target-date funds, and sometimes company stock. You do not have the freedom to invest in individual stocks, bonds, or annuities within most 401(k) plans, though some plans now offer annuity options as part of their investment lineup.

Required minimum distributions (RMDs) begin at age 73 for 401(k) plans. This means the IRS requires you to start taking a minimum amount out of the account each year, even if you do not need the money. Failure to take your RMD results in a penalty of 25 percent of the amount you should have withdrawn.

How an IRA Works

An individual retirement account (IRA) is a personal retirement savings account that you open on your own, independent of any employer. There are two main types: the traditional IRA and the Roth IRA. A traditional IRA works similarly to a 401(k) in that contributions may be tax-deductible and withdrawals in retirement are taxed as ordinary income. A Roth IRA uses after-tax contributions, meaning you do not get a deduction up front, but qualified withdrawals in retirement are completely tax-free.

For 2026, the IRS contribution limit for IRAs is $7,500 per year. If you are age 50 or older, you can contribute an additional $1,000 in catch-up contributions, bringing your total to $8,500. These limits are significantly lower than 401(k) limits, which is one reason many people use both accounts.

IRAs offer broader investment flexibility than most 401(k) plans. You can invest in individual stocks, bonds, mutual funds, exchange-traded funds (ETFs), certificates of deposit, and even annuities within an IRA. This flexibility makes IRAs a good complement to a 401(k), especially if your employer plan has limited investment choices.

Traditional IRAs require RMDs starting at age 73, just like 401(k) plans. Roth IRAs, however, have no required minimum distributions during the account owner's lifetime, which makes them a powerful tool for tax planning and leaving assets to heirs. The 10 percent early withdrawal penalty applies to IRA withdrawals before age 59 and a half, though Roth IRAs allow you to withdraw your contributions (not earnings) at any time without penalty.

How an Annuity Works

An annuity is a contract between you and an insurance company. You give the insurance company a lump sum or a series of payments, and in return, the company promises to pay you a stream of income, either starting immediately or at a future date. Annuities are the only financial product that can guarantee income for life, which is why they are often used to supplement 401(k) and IRA savings.

One of the biggest differences between annuities and retirement accounts is that annuities have no IRS-imposed contribution limit. You can put $10,000 or $1,000,000 into an annuity in a single year. This makes annuities especially useful for people who have already maxed out their 401(k) and IRA contributions and still want to save more on a tax-deferred basis.

Like 401(k)s and IRAs, earnings inside an annuity grow tax-deferred. However, non-qualified annuities (those purchased with after-tax dollars outside of a retirement account) do not offer an upfront tax deduction. When you withdraw money, earnings are taxed as ordinary income, and withdrawals before age 59 and a half are subject to a 10 percent penalty. Annuities also come with fees, including mortality and expense charges, administrative fees, and potential surrender charges if you withdraw funds during the surrender period.

Non-qualified annuities do not have required minimum distributions. This is a notable advantage over 401(k)s and traditional IRAs, because it means you can let your money continue to grow tax-deferred for as long as you want. Qualified annuities held inside an IRA or 401(k) are subject to that account's RMD rules.

Side-by-Side Comparison

The following comparison highlights the key differences across the three retirement income vehicles:

Contribution limits: The 401(k) allows up to $24,500 per year ($32,000 with catch-up for those 50 and older). The IRA allows up to $7,500 ($8,500 with catch-up). Annuities have no IRS-imposed contribution limit.

Tax deduction on contributions: Traditional 401(k) contributions are pre-tax and reduce your taxable income. Traditional IRA contributions may be tax-deductible depending on your income and whether you have an employer plan. Non-qualified annuity contributions are made with after-tax dollars and are not deductible.

Tax-deferred growth: All three offer tax-deferred growth. You do not pay taxes on gains, interest, or dividends until you take a withdrawal.

Early withdrawal penalty: All three impose a 10 percent IRS penalty on withdrawals taken before age 59 and a half, with limited exceptions. Annuities may also charge surrender fees on top of the IRS penalty.

Required minimum distributions: 401(k)s and traditional IRAs require RMDs beginning at age 73. Roth IRAs have no RMDs during the owner's lifetime. Non-qualified annuities have no RMDs. Qualified annuities inside IRAs or 401(k)s follow the RMD rules of the host account.

Guaranteed income: Only annuities can provide a guaranteed income stream for life. A 401(k) or IRA allows you to withdraw funds, but there is no guarantee you will not run out of money. An annuity's guaranteed income can serve as a personal pension.

Employer match: Only 401(k) plans offer employer matching contributions. Neither IRAs nor annuities provide this benefit. An employer match is one of the highest-return opportunities available, which is why most advisors recommend contributing at least enough to your 401(k) to capture the full match before funding other vehicles.

When an Annuity Supplements Your Retirement Accounts

An annuity is not a replacement for a 401(k) or IRA. It is a complement. The most effective retirement plans often use all three. Here are the situations where adding an annuity makes the most sense:

First, if you have already maxed out your 401(k) and IRA contributions for the year and still have money to save, an annuity allows unlimited additional tax-deferred savings. There is no contribution cap, which makes it the only option for high earners who want to shelter more money from current taxes.

Second, if you are approaching retirement and want to convert a portion of your savings into guaranteed lifetime income, an annuity can fill that role. Social Security provides a base layer of guaranteed income, but for many retirees it is not enough. An annuity acts like a personal pension, covering essential expenses so you can invest the rest of your portfolio more aggressively or preserve it for other goals.

Third, if you are concerned about outliving your money, an annuity provides longevity protection that 401(k)s and IRAs cannot. No matter how carefully you plan your withdrawal rate, there is always a risk that market downturns or unexpectedly long life will deplete your retirement accounts. A lifetime annuity eliminates that risk for the income it covers.

Tax Treatment Differences

Understanding how taxes work across these three options is critical for effective retirement planning. The tax treatment differs depending on the type of account and when you pay taxes.

With a traditional 401(k) or traditional IRA, you pay taxes later. Contributions reduce your taxable income now, growth is tax-deferred, and every dollar you withdraw in retirement is taxed as ordinary income. This works well if you expect to be in a lower tax bracket in retirement than you are now.

With a Roth 401(k) or Roth IRA, you pay taxes now. Contributions are made with after-tax dollars, but growth and qualified withdrawals are completely tax-free. This is advantageous if you expect your tax rate to be higher in retirement or if you want the flexibility of tax-free income.

With a non-qualified annuity, you use after-tax dollars to purchase the contract, so there is no upfront tax deduction. Your earnings grow tax-deferred. When you take withdrawals, the IRS considers earnings to come out first (last-in, first-out, or LIFO), which means your initial withdrawals are fully taxable until all earnings have been distributed. After that, withdrawals of your original premium are tax-free because you already paid taxes on that money. If you annuitize the contract (convert it to a stream of payments), each payment is split between taxable earnings and a tax-free return of premium using the exclusion ratio.

Having a mix of pre-tax (401(k), traditional IRA), tax-free (Roth), and tax-deferred (annuity) accounts gives you the most flexibility to manage your tax liability in retirement. Consult a tax professional for advice specific to your situation.

RMD Rules and How They Differ

Required minimum distributions are a key planning consideration. The IRS requires you to withdraw a minimum amount each year from certain retirement accounts once you reach a specific age. Failing to take your RMD results in a penalty of 25 percent of the amount you should have withdrawn (reduced to 10 percent if corrected within two years).

For 401(k) plans and traditional IRAs, RMDs begin at age 73. The amount is calculated by dividing your account balance by a life expectancy factor from IRS tables. As you age, the required percentage increases, which means more of your balance is distributed and taxed each year.

Roth IRAs have no RMDs during the account owner's lifetime. This makes them an excellent tool for tax-free growth and legacy planning. Roth 401(k)s previously required RMDs, but beginning in 2024, Roth 401(k)s are also exempt from RMDs during the owner's lifetime.

Non-qualified annuities have no RMD requirement. You can leave the money growing tax-deferred indefinitely. However, if you purchase an annuity inside an IRA or 401(k) (a qualified annuity), it is subject to that account's RMD rules. One strategy some retirees use is to annuitize a portion of their IRA into lifetime payments, which can satisfy the RMD requirement for that portion of the account while guaranteeing income.

Building a Combined Retirement Strategy

The most effective retirement income plans typically combine all three vehicles in a sequence that maximizes the benefits of each one. Here is a common approach that many financial advisors recommend:

Step one: Contribute enough to your 401(k) to capture the full employer match. This is the highest guaranteed return on your money and should be the first priority for virtually everyone with access to an employer plan.

Step two: Fund a Roth IRA up to the annual limit if you are eligible. The tax-free growth and withdrawal benefits of a Roth IRA add valuable tax diversification to your retirement plan.

Step three: Max out your 401(k) contribution to the full $24,500 (or $32,000 with catch-up). This provides additional pre-tax savings and reduces your current tax bill.

Step four: Consider a non-qualified annuity for additional tax-deferred savings. With no contribution limit, an annuity allows you to shelter as much additional income as you want from current taxes while also adding the option of guaranteed lifetime income when you are ready to retire.

This sequence is a general guideline, not a one-size-fits-all prescription. Your specific situation, including your income, tax bracket, employer plan quality, risk tolerance, and retirement timeline, may call for a different approach. Consult a financial advisor to build a plan tailored to your goals.

The Bottom Line

A 401(k) gives you employer matching and high contribution limits with pre-tax dollars. An IRA adds tax-advantaged savings with broader investment flexibility. An annuity provides unlimited contributions, no required minimum distributions (for non-qualified contracts), and the unique ability to guarantee income for life. None of these tools is inherently better than the others. They serve different purposes, and the strongest retirement plans use all three in combination.

Start by capturing any employer match in your 401(k), then build tax diversification with a Roth IRA, and consider an annuity when you have additional savings to shelter or when you need a guaranteed income floor in retirement. The earlier you begin funding these accounts, the more time your money has to grow tax-deferred. Consult a financial advisor to determine the right allocation across all three vehicles based on your personal circumstances and retirement goals.