How Does a 401k Work?
Jason Stolz CLTC, CRPC
Many retirees and pre-retirees ask us “How Does a 401k Work?”. A 401(k) is an employer-sponsored defined contribution plan that lets you save for retirement with tax advantages. You choose a percentage of pay to defer each paycheck, your employer may add a match or profit-sharing, and your money is invested for long-term growth. Traditional 401(k) contributions reduce taxable income today; Roth 401(k) contributions use after-tax dollars and can allow tax-free qualified withdrawals later. Employer dollars may vest over time; your own deferrals are always yours.
Free Retirement Income Review
See how your 401(k) translates into reliable income—and whether adding an annuity could improve outcomes.
401(k) Basics—Contributions, Investments, Taxes
- Contributions: You elect a percentage of pay. Employers may add a match, safe harbor, or profit-sharing.
- Traditional vs. Roth: Traditional lowers today’s taxable income; Roth uses after-tax dollars for potential tax-free qualified withdrawals.
- Investments: Plans typically offer index or target-date funds. You assume market risk and reward.
- Access: Intended for retirement; early withdrawals can trigger taxes/penalties unless an exception applies.
- Job change or retirement: You can usually complete a direct rollover to maintain tax deferral.
Why Many Retirees Pair a 401(k) with an Annuity
When asking “How does a 401k Work”, you also want to consider “How does a 401k work IN RETIREMENT”. A 401(k) is a great savings vehicle, but it doesn’t guarantee lifetime income. As retirement nears, the question becomes less “How fast can I grow?” and more “How do I not run out?” That’s where annuities help:
- Guaranteed lifetime income: Convert a portion of assets into a paycheck you can’t outlive.
- Principal protection choices: MYGA, fixed, and fixed indexed annuities can shield against market loss.
- Tax deferral continues: Qualified rollovers keep tax deferral; non-qualified annuities also grow tax-deferred.
- Behavioral guardrails: A structured income plan reduces sequence-of-returns risk.
- Spousal and legacy options: Joint-life payouts and beneficiary protections.
Not sure how much of your 401(k) to earmark for guaranteed income vs. market growth? Use the calculator below, then compare options on our Annuities page.
Estimate Your Lifetime Income
How a 401(k) Rollover to an Annuity Works
- Pick your annuity lane: MYGA (multi-year guaranteed), fixed indexed, or immediate income—based on timeline and goals.
- Use a direct rollover: Move funds custodian-to-custodian to maintain tax deferral—no checks to you. Start with What Is a Direct Rollover?
- Elect income/benefit options: Single or joint lifetime payouts, penalty-free withdrawals, and beneficiary settings.
- Coordinate income sources: Align start dates with Social Security and pensions; plan RMDs if applicable. See Does Annuitization Satisfy RMDs?
If you’re moving from a 403(b) or 401(k), here’s a practical guide: How to Roll Over a 403(b) or 401(k) into a Guaranteed Annuity.
Designing a Durable Retirement Paycheck
- Income floor: Cover essentials with guaranteed sources; explore lifetime income quotes.
- Inflation defense: Consider annuity inflation protection or staggered start dates.
- Optional upside: Fixed indexed annuities pair growth potential with principal protection; learn the laddering approach.
- Late-life planning: A QLAC can push RMDs on a portion of IRA dollars and create income later in life.
Before you retire, review our Pre-Retirement Check List to tie up loose ends.
Turn Savings into a Retirement Paycheck
Compare MYGA, fixed indexed, and immediate income options side-by-side.
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FAQs: 401(k)s and Annuities
How does a 401(k) reduce my taxes?
Traditional 401(k) contributions lower your current taxable income and grow tax-deferred. Roth 401(k) uses after-tax dollars; qualified withdrawals can be tax-free.
What happens to my 401(k) when I change jobs?
You can leave assets in the old plan (if allowed), move them to a new plan, or complete a direct rollover to an IRA or annuity to maintain tax deferral.
Why consider an annuity if I already have a 401(k)?
A 401(k) builds savings, but annuities can provide guaranteed lifetime income, principal protection features, and structured withdrawals that reduce sequence-of-returns risk.
Can I roll my 401(k) into an annuity without paying taxes now?
Yes—when done as a direct rollover to a qualified annuity/IRA, you maintain tax deferral.
How do RMDs work if I use an annuity?
RMDs still apply to qualified accounts. Many contracts allow RMD withdrawals while keeping your income plan on track. See Does Annuitization Satisfy RMDs?
What annuity types should I consider?
MYGA for guaranteed rate terms, fixed indexed for growth potential with downside protection, and immediate annuities for income starting now. Explore options on our Annuities page.
How do I estimate my annuity income?
Use the embedded calculator above, then request lifetime income quotes tailored to your age, state, and goals.
