Annuity vs. 401k: Key Differences, Benefits, and Drawbacks for US Expats

This article compares an annuity vs. 401(k), outlining their key differences, benefits, and limitations. Additionally, it explains the process of converting a 401(k) to an annuity and discusses key tax, regulatory, and currency considerations when contributing to and accessing these retirement products as a US expat.

What is a 401k?

A traditional 401(k) is an employer-sponsored retirement savings plan funded from a portion of your pre-tax salary.

Your US employer can also offer an employer match, which refers to providing additional 401(k) contributions that match your own contributions up to a specific percentage of your income.

The employee contribution limit to a 401(k) cannot exceed $23,500 in 2025, excluding any employer contributions.

However, individuals aged 50 and over can contribute an additional $7,500, while for tax years 2025–2028, those aged 60–63 qualify for an enhanced catch-up contribution of $11,250, subject to legislative change.

The contributions are invested on your behalf to grow your account balance. The funds accumulate on a tax-deferred basis and are generally taxed as ordinary income when withdrawn. Withdrawals made before age 59½ may be subject to an early withdrawal penalty of 10%.

Additionally, under the Required Minimum Distributions (RMDs), you must begin withdrawing funds from a traditional 401(k) from age 73 to avoid tax penalties.

While the majority of 401(k)s are traditional accounts, you can also choose a Roth 401(k) as your retirement savings plan. In this case, contributions are made from your after-tax salary, making qualified withdrawals generally tax-free.

Since 2024, Roth 401(k) plans are no longer subject to Required Minimum Distributions.

What Is an Annuity?

Annuities are insurance products designed to provide a steady income primarily during retirement. They are issued by insurance companies, which allow you to make a lump sum contribution or periodic payments that are converted to an income stream at a later date.

You can contribute to an annuity using either pre-tax or after-tax dollars. The two methods differ as follows:

1. Pre-tax annuities: Also known as qualified annuities, pre-tax annuities are typically funded through a rollover from a 401(k) or a similar tax-qualified retirement account. As a result, they remain subject to the tax rules governing the original retirement account rather than independent annuity contribution limits. Additionally, both the original investment and accumulated returns are taxed as ordinary income upon withdrawal.
2. Post-tax annuities: Known as nonqualified annuities, these annuities have no contribution limits imposed by the IRS. Investment earnings are taxed as ordinary income upon withdrawal on a last-in, first-out (LIFO) basis, meaning earnings are withdrawn and taxed before the principal, which is returned tax-free.

The amount of income you receive from an annuity depends on factors such as:

• Your age
• Invested sum
• Investment returns
• Duration of the accumulation and payout periods
• Type of accumulation annuity you purchase

Large investments and a longer accumulation period typically result in higher monthly annuity payments, although income levels also depend on prevailing interest rates and the terms of the annuity contract.

Types of Accumulation Annuities

Depending on your financial goals and risk tolerance, you can purchase the following types of annuities:

Types of Income Annuities

At the time you purchase an annuity, you can opt to receive the income immediately or at a later date, regardless of the type of accumulation annuity you choose. Consequently, annuities are classified as one of the following during the payout phase:

1. Immediate income annuities: You purchase an annuity with a lump sum and begin receiving a fixed amount of monthly income within one month to a year. You can choose whether to receive payments for a specified period or for the remainder of your life.
2. Deferred income annuities: You can contribute a lump sum or make a series of payments to an insurance company and, in exchange, the company pays out a pre-determined monthly amount as an income stream at a specific point in future. The period between the initial payment and the start of income payments is known as the deferral period, during which the annuity’s future income value may increase.

Is a 401k an Annuity? Common Misconception Resolved

Although both vehicles serve similar purposes for retirement planning, a 401(k) is not the same as an annuity.

While the latter is a specific insurance product, the former is a retirement account that can hold various financial investments and, in some cases, insurance-based products, including stocks, bonds, mutual funds, and annuities, depending on the plan design.

More specifically, a 401(k) is primarily utilised to accumulate and grow retirement savings, while the primary purpose of annuities is to convert accumulated savings into a predictable income stream, typically during retirement.

What Is the Difference Between an Annuity and 401k?

Both 401(k) plans and annuities enable tax-deferred income growth, may include early withdrawal penalties, and generally allow remaining balances to be passed to beneficiaries, subject to product and plan terms. However, the two differ in their core features and purpose.

The following table outlines the key differences between a 401(k) and an annuity:

What Are the Pros and Cons of a 401k?

In addition to the differences in their key features, a 401(k) and an annuity may entail different advantages and drawbacks for prospective retirees.

The primary benefits of a 401(k) plan include:

• Employer match: Where applicable, an employer match can significantly increase your retirement savings at no additional cost.
• Potential for substantial fund growth: Considering that 401(k) contributions are invested in diverse assets, including high-return investments such as stocks, and the tax on returns is deferred, your savings have significant growth potential.
• Immediate tax reduction: Traditional 401(k) payments are made with pre-tax dollars, which are taxable only on withdrawal. This reduces your annual taxable income, allowing you to preserve more wealth during the accumulation phase.

However, a notable drawback of a 401(k) plan is that the investment options are pre-determined by your employer, which means you cannot develop your own investment strategy.

Although the contributions are invested with the goal of increasing your retirement savings, returns are not guaranteed. Investment performance is subject to market volatility and may lead to financial losses.

Additionally, you must adhere to the yearly contribution limits and withdrawal rules to avoid tax penalties.

What Are the Pros and Cons of Annuities?

The main advantage of investing in a fixed annuity is that the insurance company contractually agrees to provide a guaranteed minimum return, subject to the insurer’s financial strength and the terms of the policy. As a result, fixed annuities may provide a predictable income stream that is less exposed to market volatility.

Unlike 401(k)s, nonqualified annuities—most commonly purchased to provide retirement income—impose no contribution limits, allowing greater flexibility when allocating larger sums for retirement income planning.

Earnings inside an annuity generally grow tax-deferred until withdrawals begin, with the tax treatment depending on whether the annuity is qualified or nonqualified. Variable annuities can also offer market exposure, although returns and account values can fluctuate based on underlying investment performance.

However, annuities include the following disadvantages:

• Limited liquidity: Annuities are generally less liquid than 401(k)s, although many contracts permit limited annual withdrawals without surrender charges. Early withdrawals beyond these limits may trigger surrender charges, which can be as high as 10% of the contract value.
• High fees: Investing in an annuity may involve multiple layers of fees, including administrative charges, commissions, and investment-related costs. These can be significant, particularly for variable annuities, although costs vary by product and provider, and some employer-sponsored 401(k) plans may also carry relatively high expense ratios.
• Complexity: Annuity contracts are complex and require a clear understanding of product features, tax treatment, and long-term implications to be managed effectively.

Should you decide to purchase an annuity, our financial advisers at Titan Wealth International can help you understand the contract and assess whether it aligns with your retirement goals.

We can also evaluate your tax residency and cross-border circumstances to recommend an expat-specific retirement income strategy that supports long-term income sustainability.

Can You Roll a 401k Into an Annuity?

You can roll over a 401(k) to an annuity without triggering immediate tax charges, as long as you adhere to the IRS rollover rules.

You can opt for two types of rollovers:

1. Direct rollover: The 401(k) provider transfers funds directly to the financial institution holding your annuity. This method reduces transfer complications and avoids the mandatory withholding tax.
2. Indirect rollover: The 401(k) provider transfers the funds directly to you, and it is your responsibility to deposit the full gross amount to the insurer’s account within 60 days. If you miss the 60-day deadline, the transferred amount is generally taxable, and it may also be subject to a 10% early-distribution penalty if you’re under 59½. Additionally, this option includes a 20% federal withholding tax that you can reclaim as a refund on your US tax return.

Provided your 401(k) plan allows it, you can convert a portion instead of your entire balance into an annuity. This strategy is particularly suitable for individuals who have reached age 59½ and wish to withdraw a portion of their savings immediately while creating a steady stream of retirement income.

What Are the Benefits of Rolling Over a 401k to an Annuity?

Rolling a 401(k) into an annuity provides the following benefits:

• Tax-efficiency: Converting a 401(k) to an annuity is tax-free if you are transferring funds directly. Such transfers are not treated as taxable distributions, and once the transfer is complete, the funds continue growing on a tax-deferred basis.
• Predictable retirement income: Leaving your savings in a 401(k) exposes them to market volatility. Transferring some or all of your 401(k) to a fixed annuity ensures you receive regular retirement income that cannot be affected by poor market performance.
• Longevity protection: Annuities can be structured to provide income for a specified number of years or for the remainder of your life, thereby mitigating the risk of outliving your savings.

Required Minimum Distributions vs Lifetime Income Planning

Traditional 401(k) plans are subject to Required Minimum Distributions (RMDs starting from age 73 for most retirees), regardless of whether the income is needed.

These mandatory withdrawals can increase taxable income and complicate tax planning for US expats, particularly where local taxes or withholding obligations also apply.

By contrast, certain annuity structures can be designed to provide predictable lifetime income that more closely aligns with spending needs.

When used appropriately, annuities may help smooth retirement income and manage the timing and level of taxable distributions, reducing the risk of large, compulsory withdrawals later in life.

However, decisions to annuitise retirement savings are generally irreversible, and annuity income may be taxed differently depending on whether the annuity is qualified or nonqualified and how it is treated in your country of residence.

Therefore, careful planning is essential before committing assets to long-term income arrangements.

401k vs. Annuity: Key Considerations for US Expats

In addition to the general considerations, features, benefits, and drawbacks of investing in an annuity vs. a 401(k), US expats must also consider the cross-border implications of these retirement products. More specifically, it is essential to take the following into account:

1. Cross-border tax obligations
2. US withholding tax considerations
3. Country-of-residence tax treatment differences
4. Currency considerations
5. Regulatory and residency considerations

Cross-Border Tax Obligations

Traditional 401(k) withdrawals are generally taxable in the US if you are a US national, even if you live abroad. The same applies to withdrawals of investment earnings from non-qualified annuities. Because your country of residence may also tax the same income, this can result in double taxation.

However, if your country of residence has a double tax agreement (DTA) with the US, its provisions may reduce withholding tax or assign taxing rights in a way that mitigates double taxation. It is important to note that many non-US jurisdictions do not recognise US annuities as pension products, which can result in unfavourable local tax treatment even where a treaty exists.

Additionally, some US-issued annuities may restrict availability, servicing, or ongoing contributions for non-US residents, and local financial regulations in your country of residence may limit how annuities can be advised on or distributed.

US Withholding Tax Considerations

Withdrawals from a traditional 401(k) and distributions from US-issued annuities are generally subject to US federal withholding tax at source. While double tax agreements (DTAs) may ultimately reduce or eliminate US tax liability, treaty benefits are not always applied automatically at the time of payment.

As a result, US expats may experience higher initial withholding and must subsequently reclaim excess tax through their US tax return. This can create short-term cash-flow constraints, particularly for retirees relying on regular income payments.

Ensuring the correct tax forms are in place and structuring distributions appropriately can help reduce unnecessary withholding and improve retirement income efficiency.

Country-of-Residence Tax Treatment Differences

While 401(k) plans are generally recognised as pension arrangements in many jurisdictions, annuities may be classified differently under local tax law. In some countries, annuities are treated as investment or insurance products rather than retirement vehicles.

This distinction can result in less favourable tax outcomes, including the annual taxation of investment growth, exposure to wealth taxes, or additional reporting requirements. These risks are particularly relevant for US expats living in jurisdictions with strict rules on foreign investment or insurance products.

Before converting a 401(k) into an annuity, it is important to consider how the product will be taxed in your country of residence, not solely under US tax rules.

Currency Considerations

Since 401(k)s and annuities are US-based retirement products, you can typically only access your savings in US dollars.

This exposes your funds to currency exchange risks, particularly if you live in a country with a depreciating local currency.

To reduce the impact of foreign exchange (FX) movements on your retirement income, you may consider converting partial lump sums at favourable exchange rates.

It is also advisable to work with a professional financial adviser to develop currency management or hedging strategies that help minimise the effects of currency fluctuations on long-term retirement income.

Regulatory and Residency Considerations

Additionally, some US-issued annuities may restrict availability, servicing, or ongoing contributions for non-US residents, and local financial regulations in your country of residence may limit how annuities can be advised on or distributed.