Annuities and pension funds are both financial mechanisms designed to provide retirees with steady streams of income. However, they differ in that while annuities are usually products that individuals buy for their own benefit, the term "pension fund" generally refers to the collective benefit fund that employees of a company or government pay into over time. Pension funds are controlled by the employer instead of the individual, although both pension funds and annuities are usually operated by an insurance or financial services company.
A pension fund is a pool of money that the workers and, possibly, employers of a particular company all pay into using a portion of their salary. The money is managed either in-house or by a financial services company, so that it can grow through investment. When workers retire, they are guaranteed a series of payments to support them, and the money is drawn from the collective pension fund. The fact that the fund is invested means that there is room for growth, but also the risk of loss.
An annuity is a financial product that is designed to provide a stream of income to a person. The individual can buy into an annuity fund, similar to a pension fund, and then arrange for the details of the annuity contract, such as the length of the annuity and whether the payments will be fixed or vary with how well the fund is growing. For example, the individual can buy an annuity that would pay out for the rest of their lifetime, or one that could pay for 25 years, with the payments going to the individual's spouse if the primary beneficiary dies before the term ends.
The basic idea for both an annuity and a pension is to replace the retired individual's income from a salary with an income from a financial service paid for with money earned while working. In both cases, the annuity or pension fund provides a person with money to live on after she retires.
The primary difference between an annuity and a pension fund is that a pension fund comes from a person's employer. For example, public employees in California obtain pensions through the CalPERS system. But annuities are a separate set of products that anyone can buy, not just those who work at a particular place. It is also possible to supplement income from a pension by buying an annuity, or even to use the funds from a pension to buy an annuity that might have better terms. In any case, pensions and annuities both support retirees, but originate from the employer and the individual, respectively.
- Hemera Technologies/AbleStock.com/Getty Images