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Annuities vs. Mutual Funds for Retirement


When choosing investments for your retirement plan, you’ll have a lot of options, including annuities and mutual funds. While both can play an important role in your retirement income plan, they are very different assets with unique characteristics. If you’re choosing between the two options, know the key characteristics and their pros and cons. You can also work with a financial advisor to find the right investments that will prepare you for your retirement goals. 

What Are Annuities?

An annuity is a contract between you and an insurance company. You purchase the contract and the insurer agrees to pay you back a certain amount for a set amount of time.

You can buy the annuity in a lump sum or pay for it in regular installments, such as monthly or yearly. Your payment plan might allow you to start getting money either right away or on a specific date – for instance, once you reach retirement. You can also set up the payments that you receive in the form of monthly installments.

There are two major kinds of annuities: fixed and variable. A fixed annuity allows you to get a specific amount of money for the duration of the term. This is a great way to consistently pay yourself a set amount. But if the market trends up, inflation could mean you would get a lower return than if you had chosen a variable annuity.

Variable annuities determine your payments based on their performances through sub-accounts, which is why they’re sometimes confused with mutual funds. Sub-accounts also pool money together from investors to buy stocks and bonds. If the market tanks, your payouts will significantly drop. But if the market is doing well, you could get a higher payout than you would have gotten with a fixed annuity.

A major advantage of annuities is that they guarantee you some kind of regular income, usually until death. Without a paycheck, you may feel a little unsure of how you’ll be able to keep up with your current lifestyle. If you’re planning to stop working after you retire, this could give you a set amount of money to expect every month.

Variable annuities are tax-deferred, which means you don’t need to start making income tax payments on the money in your variable annuity until you begin to receive distributions. The money you contribute to your annuity will grow tax-free.

The downside to annuities is the high cost of fees. Because of administrative fees and fund expenses, variable annuities can get costly. This might prompt you to seek out less expensive options with better returns.

What Are Mutual Funds?

annuity vs mutual fund

Mutual funds are a “basket” of securities, like stocks and bonds, which individual investors can buy into. Your brokerage or other investment accounts will likely include mutual funds as an investment option. It’s a quick and easy way to buy many different stocks, bonds and other securities without taking the time to hand-select each of them.

This can also provide instant diversification to your portfolio. Investing in mutual funds involves lower risk than buying individual stocks and bonds because you’re buying a portion of a stock along with a pool of other investors.

Some mutual fund managers charge sales commissions. These mutual funds are called “load” mutual funds. “No-load” funds don’t charge a sales commission fee but might have other fees, which are expressed as the fund’s expense ratio. When reviewing what mutual funds to buy, be sure to review fees based on transactions, your account balance and what you pay your account manager.

Mutual funds are a great option if you want to start investing but don’t have the time to devote to researching many different stocks, bonds and other securities. In general, they have lower fees than annuities, which means a higher rate of return on your investment.

A downside to mutual funds is the lack of guaranteed earnings compared to annuities. Unlike annuities, mutual funds don’t promise a specific amount. In fact, you might lose money, depending on market conditions. While the rate of return is higher for mutual funds, so is the risk.

Annuity vs. Mutual Fund: Which Is Better?

The right choice for you will depend on your retirement goals and long-term plan. If you’re getting fairly close to retirement age and would be comfortable with a guaranteed income stream then an annuity could be a good option for your needs. The longer you have before retirement then the more time you have to develop more growth, meaning a mutual fund might make more sense.

Choosing between annuitites and mutual funds depends heavily on your personal preferences and how much money you need to retire. Neither is meant to be used by themselves to pay for college. Instead, it’s important to establish an entire investment strategy that involves one or both of these strategies.

The Bottom Line

annuity vs mutual fund
If you’re unsure about which investment to try, it may help to determine what kind of investor you are and what your goals are.

Annuities offer a guaranteed payout. But with higher fees, you may not get as much as you would with mutual funds. And while some annuities let you take advantage of a growing market or rising interest rates, you likely won’t see your money grow as much as you would if you invested directly in the market with a mutual fund.

Mutual funds offer instant portfolio diversification and lower fees, and they also let you realize significant growth when the market (or a sector thereof) is on the rise. But they also have the potential of earning less or even lose money. The lack of security may be a turn-off, particularly for those seeking reliable income in retirement.

Tips for Retirement

  • Retirement planning involves navigating a lot of variables, which is why even the most money-savvy people like to work with a financial professional. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • When investing, be sure to review all your options before jumping into one. Different profiles have different levels of risk tolerance. Using an asset allocation calculator may help you get a good sense for what your portfolio should look like.

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