What are the differences between annuities, IRAs, and 401(k) plans, and how do they fit into my estate plan?

Annuities, individual retirement accounts (IRAs) and 401(k) plans are all types of investments that can help you plan for retirement, as well as for the inheritance that you wish to leave your children. All of these investment options may provide tax-deferred growth and certain other tax advantages, depending on your situation. Furthermore, all of these options exclude your invested assets from costly probate proceedings, and provide a source of income for you during retirement that is taxed at a lower rate than regular income. However, there are important differences between these investment options, as well, which make it essential that you consult an investment advisor, an estate planning lawyer, and/or a tax advisor prior to deciding how to invest your money.
First, although all of these investment options provide for tax-deferred growth, the other tax advantages derived from these investment options varies according to your financial situation. For most investors, making the maximum contributions to a 401(k) through an employer and/or an IRA will be more advantageous than initially turning to an annuity as an investment option. For example, all contributions to a 401(k) plan through your employer are made on a pre-tax basis. This means that you not only get the benefit of your 401(k) contributions growing on a tax-deferred basis, but you simultaneously will reduce your taxable income for the year. Another tax advantage of 401(k) plans is that most employers offer some sort of matching funds up to a certain percentage of your 401(k) contributions. Since you are getting free money from your employer to contribute to your 401(k), and enjoying significant tax savings, contributing to a 401(k) plan, at least at a level designed to take full advantage of any matching fund by your employer, is typically the best option in terms of an investment that combines tax savings with the sheltering of your assets from probate.
Next, an IRA offers substantial tax advantages, as well. Based on your income level, a certain amount of contributions to an IRA are deductible on your income tax return. Depending on the type of IRA you choose, you may also enjoy tax-deferred growth of your assets. Therefore, it is generally advantageous for investors to reap the full tax benefits of an IRA before turning to an annuity for investment purposes. Furthermore, keep in mind that if you have invested your funds in a variable annuity through a 401(k) plan or IRA, you will not receive any additional tax advantage from the variable annuity. In this respect, then, choosing an annuity will not be helpful to you, unless you wish to take advantage of some other feature of an annuity, such as the death benefit, or the fact that you will be guaranteed a certain level of income for the remainder of your life.
As you can see, all of these investment options – annuities, 401(k) plans, and IRAs – offer distinct tax advantages and other attractive features, which are largely dependent on your particular financial situation. Therefore, before utilizing any of these investment options, you should consult professional advisors in order to create a retirement and estate plan that best meets your needs, as well as the needs of your family.

The information on this page is meant to provide a general overview of the law. The laws in your state and/or city may deviate significantly from those described here. If you have specific questions related to your situation you should speak with a local attorney.

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