There’s more than one way to crack an egg — and to build your nest egg.
When comparing annuities versus mutual funds, the right choice depends on your current financial health, risk tolerance, and retirement goals. Read on to determine which strategy maybe right for you.
Mutual funds are pooled investment products managed by financial professionals. These professionals collect money from multiple clients to invest in a diversified asset portfolio, such as stocks, bonds, or other securities
Mutual funds are typically structured around specific investment objectives, such as growth, income, or risk management. Investors will share in the fund’s gains or losses proportionally based on their holdings.
Because of a mutual fund’s diversification, professional management, and liquidity, this investment strategy is popular among individual and institutional investors alike.
Mutual funds are an accessible and risk-flexible option for most people, but there are some drawbacks. Here are the pros and cons of this investment type.
With mutual funds, you have relatively quick access to your money. If you sell shares in a mutual fund — usually when the stock market closes for the day — you’ll generally have cash inyour bank within 2–3 business days.
Mutual funds take the guesswork out of investing. Instead of assembling your own portfolio of individual stocks and bonds, you can rely on professional money managers to make these decisions for you. Sometimes, these pros actively invest based on specific earning objectives.Or they might invest passively with the intent of tracking popular market indexes, such as theS&P 500®.
Unless you own mutual funds inside a tax-advantageous account, when you sell mutual fund shares you’ll typically be liable for taxes on capital gains. The same applies even if you don’t sell. When the fund distributes capital gains and dividend payments to shareholders on transactions that happen within the mutual fund portfolio, it reports these earnings to the IRS, which you must report on your return come tax time.
When you invest in mutual funds, you subject yourself to the ups and downs — the volatility —of the markets you’re investing in. For example, if you own a passive S&P 500® mutual fund and stocks crash, there’s nothing a money manager can do other than encourage you to ride the wave. While this is good advice, it can also be unsettling, particularly if you’re close to needing your money.
Sold by insurance companies, annuities are financial products that generate a consistent, guaranteed income stream. You pay your chosen insurer a lump sum or consistent payments and, in return, they offer regular payouts once the predetermined date arrives (often when you hit retirement).
There are many annuity types, each serving unique policyholder interests. For instance, you might want a fixed annuity to enjoy guaranteed, fixed rate returns. And variable annuities can offer increased growth since they leverage market performance — but this also means you risk losing money due to market slumps.
When comparing an annuity versus mutual fund for retirement, consider the pros and potential downsides of annuities.
Annuities are quite straightforward — you contribute to an annuity in exchange for a payout period when you receive distributions from your account. These guaranteed payouts can be for a set period of time (e.g., 10 years) or life. And you can customize your contract with riders so it better suits your needs.
As the money in your annuity grows, you don’t pay income tax. You only pay taxes when you withdraw your money, usually in retirement. Because many retirees are in a lower tax bracket during retirement than their working years, the tax hit on distributions might not be too rough.
Annuities are designed as long-term savings and retirement planning options. They exist to alleviate the concern that you’ll outlive your money. If you want to access money from your annuity early, it will generally take a few weeks or even months to complete the process, depending on the annuity type and insurer. And you might face early withdrawal penalties or, if you sell annuity payments prematurely, get less money for them than they would be worth over the long haul.
Most annuities are sold through a broker or agent, resulting in high fees to sell and manage your annuity account. Removing these middlemen, can allow you to avoid high maintenance, administration, and commission fees.
An annuity isn’t a mutual fund — they’re completely different products with four important
differences.
Most annuities grow tax-deferred, so you don’t have to report earnings you accumulate to the IRS — you only pay taxes when you take money from an annuity.
Unless your mutual funds are tied to a retirement account like an IRA or 401(k), mutual funds regularly trigger taxable events as they distribute earnings, particularly on capital gains or dividends.
When investing in mutual funds, you generally take on more risk compared to annuities. Your returns depend on both the mutual fund you choose and, in the case of stock mutual funds, the performance of the stock market or the fund manager’s investment decisions.
Mutual funds offer a range of risk profiles, but navigating them requires more active decision-making than when selecting an annuity.
For example, for a fixed annuity versus a mutual fund, the former offers a guaranteed interest rate for a set period, protecting your money from market risk. Unlike IRS-related retirement accounts that hold mutual funds, fixed annuities have no contribution limits. And they grow tax-deferred, adding another layer of security.
For a variable annuity versus a mutual fund, the former shares some similarities with mutual funds in that its returns fluctuate with market performance. The money is invested in sub accounts that function like mutual funds, meaning there’s potential for higher growth — but there’s also more risk. That said, you can still structure your variable annuity to provide retirement income, offering a balance between investment growth and long-term financial planning.
When you invest in a mutual fund, you pay an expense ratio. This money helps fund companies cover the costs to run a mutual fund. At a 1.0% expense ratio, you’ll pay $100 for every $10,000 invested. Plus, some mutual funds charge sales loads, often ranging from 2% to 6%, when you purchase or sell shares.
Traditional annuities can come with high administrative, maintenance, and commission fees. But modern digital annuity providers can streamline the process to save you these costs.
Most annuities provide guaranteed income later in life, and your beneficiary can even receive these payouts once you pass.
Mutual funds don’t offer guaranteed income. Instead, you take out money as you wish —although withdrawal does depend on your mutual fund type. For instance, with an open-end fund (the most common type) you can withdraw money anytime. And with a closed-end fund, you can only sell your shares to another investor at market price.
Here are a couple scenarios where an annuity might be your best bet:
If you’re willing to take on more risk and deal with the attendant uncertainty, mutual funds might be better for you:
For short-term, more speculative investing, mutual funds are more attractive than annuities. This can also be the case if you seek higher returns. However, you can meet this objective if you choose a variable over fixed annuity.
The biggest disadvantage of annuities is the lack of liquidity — if you need your money early, the process can be long and costly. With mutual funds, you generally have access to your cash, penalty-free, within a few days.
The answer to this question depends on your risk tolerance and overall financial situation. If you seek more stable growth alongside guaranteed income for life, annuities are better than mutual funds because the latter simply can’t provide these benefit.
This communication is for informational purposes only. It is not intended to provide, and should not be interpreted as, individualized investment, legal, or tax advice.
