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A pension and an annuity are not the same thing, and people who sell one often talk as if they were.
The confusion costs real money. My earlier piece on how owners fund their own retirement covers why pensions faded. This one explains how they and annuities work now. A pension is a plan. An annuity is a contract. One has your employer or business behind it, and the other has an insurance company behind it. Know which you are being offered and who owes you the money, and you are ahead of most buyers.
What is a pension, in plain terms?
A pension is a promise of a set benefit in retirement, based on a formula. The IRS describes a defined benefit plan as one that provides a benefit based on a fixed formula, giving employees a fixed, pre-established benefit at retirement.1
How a pension differs from a 401(k)
In a 401(k)-style plan you build an account, and what you end with depends on contributions and investment results. In a pension the benefit is set by formula, and the employer carries the funding responsibility. The IRS notes that in a defined benefit plan the benefits are not dependent on asset returns.1
| Defined benefit (pension) | Defined contribution (401(k), solo 401(k)) |
|---|---|
| Benefit set by a formula | Balance depends on what goes in and how it is invested |
| Employer is responsible for funding | You choose contributions, up to the annual limits |
| Annual filing and an enrolled actuary required | Less complex to run than a pension |
| Predictable benefit, high cost to maintain | Flexible contributions, no promised benefit |
Can a self-employed owner have a pension?
Yes. The IRS says a defined benefit plan can be established by a business of any size, and you can have other retirement plans alongside it.1
What you take on
Read the IRS's own list of requirements. You need to file Form 5500 with a Schedule SB every year, and an enrolled actuary has to determine the funding levels and sign it. The IRS adds that an excise tax applies if the minimum contribution requirement is not satisfied.1 That last sentence is the one to underline. A pension is an obligation, not a preference.
Why a solo owner might look at it
The IRS notes that employers can generally contribute, and deduct, more each year than under defined contribution plans, and that substantial benefits can be provided within a short time.1 It also lists the downside: it is the most costly type of plan and the most administratively complex.1
For an online business with lumpy income, a required annual contribution is a serious commitment. Compare it with the flexibility described in the 2026 contribution limits breakdown, where a solo 401(k) is a different trade: you decide each year how much to contribute, up to the limits.4 This is exactly the kind of choice to model with a plan actuary and your CPA, not alone.
What happens to a pension if the company fails?
For private-sector single-employer plans, the Pension Benefit Guaranty Corporation (PBGC) steps in as trustee in a plan termination, up to a limit. The limit rises with the age at which you start collecting.2
PBGC publishes the maximum monthly amount for a straight-life annuity at 65 as $7,789.77 for 2026, and notes it is lower if you choose survivor benefits.2 Most people never reach the cap. The point is that even a pension has edges.
What is an annuity, and what are its types?
An annuity is a contract with an insurance company. FINRA says annuities are products investors might consider when planning for retirement or seeking to turn assets into a stream of income, and money invested in annuities grows on a tax-deferred basis.3
The reason people look at income contracts at all is that spending steadily from a portfolio is hard. Ben Felix, Chief Investment Officer at PWL Capital, named the mismatch in a video posted on March 16, 2025. His own answer is flexible spending, not an annuity, so I am borrowing the problem and not his conclusion.5
Portfolios are variable. Trying to squeeze constant spending from a variable asset is bound to cause problems.
That tension is why pensions and annuities exist. It is also why the cost and the liquidity trade below deserve a hard look.
Fixed, variable and indexed
- Fixed. The insurer sets the interest rate for a time and the payout. Payouts are not affected by market swings, but payments typically do not adjust for inflation.3
- Variable. Your value goes up or down with the subaccounts you choose, and you could lose money. FINRA notes that annual expenses are likely to be much higher than a typical mutual fund and that these products are a leading source of investor complaints.3
- Indexed. A mix of the two: a minimum interest rate combined with a rate linked to a market index. FINRA calls them complex and says it is hard to compare one to another.3
Immediate or deferred
An immediate annuity starts paying soon after you buy it. A deferred annuity delays the payout until later, and the payout phase is often called annuitizing.3
What are the risks and costs to question first?
FINRA lists several, and they are worth reading in full.3
- Fees. Surrender charges, mortality and expense charges, administrative fees, and charges for riders. Commissions can be high.
- Insurer risk. An annuity depends on the insurer remaining in business. There may be state protections, but annuities are not FDIC insured.
- Taxes and penalties. Gains are taxed at ordinary income rates when withdrawn, and withdrawals before 59 and a half may face a 10 percent tax penalty.
- Inside a retirement account. If you buy an annuity inside an IRA or 401(k), you get no additional tax advantage.
- Swapping. Exchanging one contract for another can bring new surrender charges and restart the clock on early withdrawal penalties.
I never ask what a product promises. I ask what it costs me to leave.
What should you ask before signing anything?
- Who owes me the money? An employer, a plan trustee or an insurer.
- What are all the fees, in dollars? Ask for a written schedule.
- What is the surrender schedule? How long, how much, and what exceptions.
- What happens if I need the money early? Test your liquidity before you commit.
- How is the person selling it paid? FINRA suggests knowing whether it is a commission and how much.
- Does this fit with the rest of my plan? See the piece on insurance for founders, which uses the same question list for life and disability policies.
My grandmother's question was about a plan, not a product. I tell that story here. Keep it in mind: income in retirement is the goal, and these tools are only ways to get there. If you are still building the foundation, start with the cash buffer and the accounts you can open yourself.
More guides are in the Investing and Retirement hub.
Educational content, not financial, tax, legal or investment advice. Talk to a licensed professional about your situation.
Keep building.Ekai
Questions people ask
What is the difference between a pension and an annuity?
A pension is a retirement plan, usually run by an employer, that pays a benefit based on a formula. An annuity is a contract you buy from an insurance company that turns a payment or a series of payments into an income stream, immediately or later.
Can a self-employed person have a pension?
Yes, through a defined benefit plan, which the IRS says can be set up by a business of any size. It generally needs an enrolled actuary and annual Form 5500 filing, and the IRS calls it the most costly and administratively complex type of plan.
Are annuities insured by the FDIC?
No. FINRA says annuities are not guaranteed by the FDIC or the Securities Investor Protection Corporation. They depend on the insurer remaining in business, and there may be state protections if an insurer fails.
What are annuity surrender charges?
Fees an insurance company charges if you take money out during a set period, often several years. Ask for the schedule in writing, because liquidity is the main trade you make with many annuities.
Sources
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