Retirement account comparisons between annuities and mutual funds should consider several important factors, including costs, the need for income, and the investor's risk tolerance. Annuities and mutual funds can be good retirement investments, but before deciding which is best for their needs, investors need to be aware of the differences between them. Let's first discuss the fundamentals of how each category functions before comparing annuities and mutual funds.
Main Points
- Mutual funds and annuities both make good retirement investments, but you should be aware of their differences.
- Annuities are often used to postpone paying taxes on investments or generate income in retirement.
- Investing in a specific set of underlying securities, such as stocks or bonds, is what mutual funds do.
- Annuities are probably the best option if you want security; if you want higher returns and don't mind taking on more risk, mutual funds might be a better option.
Basics of Annuity
The two primary categories of annuities are fixed annuities and variable annuities, which should be noted as the first distinction. A fixed annuity functions similarly to a bond in that the investor receives fixed interest payments over a predetermined period. Sub-accounts in variable annuities are frequently similar to mutual funds. As a result, when annuities and mutual funds are compared, variable rather than fixed annuities are typically used. It's also crucial to remember that annuities are insurance products and not investment securities. This is important because it indicates that the Securities and Exchange Commission does not regulate fixed annuities (SEC). As a result, unlike mutual funds, insurance companies are not required to disclose expenses in the same manner. Variable annuities are subject to SEC regulation, and one benefit of annuities as insurance products is that the insurance provider may provide a guarantee. Additionally, annuities have a tax-deferred growth feature, which exempts investors from paying taxes on dividends, interest, or capital gains while their money is invested in an annuity. When you take the money you contributed to the annuity out, there won't be any taxes due (the cost basis). Taxes can only be applied to capital gains. Annuities can also be "annuitized," which means they can be transformed into a stream of income that is typically guaranteed for a specific amount of time. You would be guaranteed to receive this periodic payment for the duration of the term, say if you chose to get a certain amount over 15 years. Payments may also be requested over different time frames, such as your lifetime or your lifetime plus a beneficiary's lifetime. The most typical uses of annuities are to delay taxes on investments or generate retirement income.Basics of Mutual Funds
Investing in a specific set of underlying securities, such as stocks or bonds, is what mutual funds do. Before purchasing mutual funds, the investor will open a brokerage account, an individual retirement account (IRA), or a 401(k) plan with their contractor. One mutual fund, also known as a "portfolio," is created by combining the various underlying security types or "holdings." In the world of investing, there are thousands of mutual funds, but they can be divided into a few different types of groups, such as bonds, large-cap stocks, small-cap stocks, international stocks, and so on. Mutual funds can be used for various goals, but they are most suitable for long-term growth or retirement income.Which is the best option for retirement?
Now that you are familiar with the fundamentals of annuities and mutual funds let's examine the key distinctions for investors, particularly those who are approaching or in retirement. Safety: Annuities are your best option if you want a guaranteed income. They can guarantee that you'll never receive less than a specified periodic payment because they are insurance products. Additionally, some annuities offer guaranteed growth, which can lessen the severity of losses during market downturns. Costs: Bear in mind that guarantees are not provided for free. Compared to mutual funds, annuities typically have much higher expenses. The way insurance companies profit from annuities is by paying you less and earning more on your money in the market in place of the guaranteed income or growth. Annuity costs can frequently exceed 2 percent, whereas mutual fund costs can frequently fall below 1 percent, particularly if you use index funds, which can have costs as low as 0.10 percent. Returns: Mutual funds outperform annuities in terms of returns thanks to lower relative expenses. Tax-deferral: While mutual funds can benefit from this tax advantage if held in a traditional IRA or Roth IRA, annuities only grow tax-deferred. Annuities are the best if you need a guarantee, which is the main takeaway for retirees and other investors. Mutual funds are a good choice if you want the chance of higher returns and don't mind assuming more market risk. If you do decide to invest in annuities, choose a low-cost fund provider like Fidelity or Vanguard because both of them offer low-cost annuities in addition to their mutual fund offerings.