Annuity vs. Mutual Fund – Forbes Advisor

Worried about not having enough money for retirement? You’re not alone. In a recent a survey released by the Stanford Center on Longevity, 55% of pre-retirees said their finances were fragile or that they were just barely making ends meet.

Annuities and mutual funds are two popular investments that can help you pay for retirement. But these two options are very different from each other, making it essential to understand what sets them apart.

What Is an Annuity?

An annuity is a contract between you and an insurance company that’s designed to provide a steady stream of income during retirement. You can fund an annuity with a single lump-sum payment or periodic payments over time.

In exchange for your contributions, the annuity company makes regular income payments to you over time. You can choose when you want the payments to begin and how long they should last—either a set number of years, like a 10-year payment period, or guaranteed payments for the rest of your life.

Different terms and costs are involved with varying payout periods, depending on the type of annuity you choose:

• Fixed annuity. This type of annuity provides fixed, guaranteed income payments for a set period of time. You pay the annuity company a lump sum or a series of payments, and they pay you a fixed return on your contributions.
• Index annuity. The income payments from an indexed annuity last for a set period of time, but they are not a fixed amount. Instead, the payouts depend on the performance of a stock market index. This type of annuity offers a minimum guaranteed return, but there is the potential for larger payouts if the market does well.
• Variable annuity. This type of annuity somewhat resembles a retirement account. Your contributions are invested in a portfolio of different funds, and your payouts depend entirely on their performance. Variable annuities have the potential for significant growth, but they can also potentially lose money.

Annuity Advantages

• Guaranteed income. With some annuities, you know precisely how much income to expect each month, making it easier to budget in retirement.
• Tax-deferred growth. Annuities provide tax-deferred growth, meaning you don’t have to worry about paying taxes until you start receiving annuity payments.
• No contribution limits. Traditional retirement accounts like 401(k)s and individual retirement accounts (IRAs) have strict annual contribution limits. By contrast, there are no contribution limits for annuities.

Drawbacks of Annuities

• Early withdrawal penalties. Depending on the annuity, you may face early withdrawal penalties if you need to access your annuity funds before retirement.
• Payments depend on the issuing company. Annuities are only as secure as the companies that issued them. If the company fails, annuity holders could be left with nothing.
• Potential high fees. Annuities tend to have higher fees than other retirement investments, which can significantly reduce returns over time.

Annuities Issuers

The quality of an annuity can vary based on the insurance company using it. Because an annuity is designed to help you in retirement, you want to choose an insurance company that is financially strong and likely to be able to afford to pay out the annuity years from now.

Before purchasing a policy, check the company’s financial strength ratings from leading insurance credit rating agencies like A.M. Best, Fitch, Kroll Bond Rating Agency (KBRA), Moody’s and S&P Global.

What Is a Mutual Fund?

A mutual fund is an investment fund that pools money from many investors and builds a portfolio of stocks, bonds or other securities. Mutual funds are run by teams of financial professionals who research investments and make decisions on the composition of the portfolio.

Investors purchase shares in a mutual fund, which represents a portion of its total assets. When you buy a mutual fund, you become a shareholder in the fund and your returns depend on how well it performs.

Mutual funds offer solid diversification. By investing in a wide range of companies, mutual fund investors can reduce their risk since they don’t have all their eggs in one basket.

It also allows smaller investors to invest in many stocks or bonds at once, without having to manually research stocks and adjust allocations.

Advantages of Mutual Funds

• Low fees. In general, mutual funds have lower fees than annuities. While annuities often charge commissions, administrative fees and mortality expenses, mutual fund fees are lower and less extensive. According to the Investment Company Institute, the average mutual fund expense ratio was just 0.47%.
• More potential for growth. With lower fees, you keep more of your returns. And because mutual funds track the performance of financial markets, they offer much greater growth potential.

• More liquid. Mutual funds provide more liquidity than annuities. You don’t have to pay surrender charges or other fees. However, if your money is in a retirement account like an IRA, you may have to pay early withdrawal penalties if you take out money before reaching 59½.

Mutual Fund Drawbacks

• No guaranteed income. Since the value of the investment assets owned by a mutual fund depends entirely on market performance, there’s no guarantee that the fund will provide a set amount of income. If the market performs poorly, you could lose money.

• Returns fluctuate based on the market. While the stock market in aggregate has historically provided dependable positive returns over the long term, there are no guarantees when it comes to individual funds. Mutual fund performance depends entirely on the market.

• Tax-deferred growth only in a qualifying retirement account. With IRAs and 401(k)s, your investment can grow tax-deferred. But if you hold mutual funds in a taxable brokerage account, you could owe income taxes on any distributions and in other cases.

Annuity vs Mutual Fund: Which Is Better for You?

When deciding between an annuity and a mutual fund, consider your retirement goals, the amount of money you want to invest and how much risk you’re willing to take.

If you are closer to retirement age and are seeking a guaranteed income stream with retirement annuities, it may be a better option for you. Annuities offer protection against market volatility and provide guarantees on your principal investment as well as a steady stream of income that can last throughout retirement.

On the other hand, if you have a longer time horizon and are interested in higher growth potential —and understand that there is more risk involved — mutual funds could be a better choice. The best mutual funds have lower fees than annuities and offer diversification benefits which can help mitigate overall risk.

Ultimately, annuity vs mutual fund comes down to personal preferences, your goals, and your current retirement savings. To help you make an informed decision and to create a plan for the future, use the retirement calculator to see how much money you’ll have in retirement.