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. 

Work with a financial advisor to find the right investments that will help you meet 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, such as when you retire. You can also set up monthly installments.

There are two major types 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. However, 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 performance 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 does well, you could receive a higher payout than with a fixed annuity.

Pros and Cons of Annuities

It is important to consider both the pros and cons of annuities.

A major reason to buy 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 plan to stop working after retirement, this can give you a set monthly income.

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 are the high fees. Because of administrative fees and fund expenses, variable annuities can get costly. This might prompt you to seek out more affordable options with better returns.

What Are Mutual Funds?

Mutual funds are a basket of securities, like stocks and bonds, that 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 the time requirement of hand-selecting 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 may have other fees, expressed as the fund’s expense ratio. 

When choosing what mutual funds to buy, be sure to review fees based on transactions, your account balance and what you pay your account manager.

Pros and Cons of Mutual Funds

Like annuities, there are both pros and cons for investing in mutual funds.

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, giving you 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 may lose money, depending on market conditions. 

While the rate of return is higher for mutual funds, so is the risk.

Annuities vs. Mutual Funds: Key Differences

Annuities and mutual funds serve different roles in retirement planning. 

Retirement Strategy

Annuities are primarily designed to provide retirement income, often through scheduled payments lasting either for a set period or for life. Mutual funds are designed for long-term growth by investing in stocks, bonds or other securities. 

This core difference shapes how each fits into a retirement strategy.

Income Predictability

Another major distinction involves income predictability. 

Many annuities offer guaranteed or contractually defined payments, appealing to retirees seeking steady cash flow. Mutual funds, on the other hand, do not offer guarantees. Their value and any income they produce depend on market performance, which means returns can vary from year to year.

Fees

Fees and costs also differ. 

Annuities often include insurance charges, administrative fees and, in some cases, surrender charges for early withdrawals. Mutual funds typically charge expense ratios, with some including sales loads or transaction fees. 

These cost structures can affect long-term returns and should be reviewed carefully.

Liquidity

Liquidity and access to money is another key difference. 

With many annuities, withdrawing funds early can trigger penalties or surrender charges. Mutual funds held in brokerage or retirement accounts are generally easier to buy or sell, although tax requirements or account rules may still apply.

Risk

Risk exposure varies, as well. 

Fixed annuities limit exposure to market fluctuations but also cap potential upside. Mutual funds are fully exposed to market movements, potentially leading to higher long-term growth but also short-term losses. 

The balance between stability and growth often drives the choice between the two.

Annuity vs. Mutual Fund: How Each Is Used in Retirement

Annuities and mutual funds are often used at different stages of retirement planning and for different purposes. Rather than serving as direct substitutes, they tend to fill separate roles within a broader strategy.

Annuities are commonly used to provide a steady retirement income stream. Payments can be structured to last for a specific period or for life, making annuities a useful tool for paying recurring expenses, such as housing, utilities and insurance.

Mutual funds are typically used for long-term growth. They are held in retirement accounts, such as IRAs and 401(k)s, or in taxable brokerage accounts to help build wealth over time and support future withdrawals.

During the accumulation years, many investors rely more heavily on mutual funds to pursue growth. As retirement approaches, some shift part of their portfolio toward income-oriented solutions, including annuities.

In retirement, mutual funds may continue to serve as a source of flexible withdrawals for discretionary spending, large purchases or unexpected costs. Annuities, by contrast, are often positioned to support baseline income needs.

Because each serves a different function, many retirement plans use both annuities and mutual funds as part of a combined approach to build wealth while managing risk.

Bottom Line

If you’re unsure about which investment to try, first determine what kind of investor you are and your overall financial goals.

Annuities offer a guaranteed payout. However, the higher fees mean you may not get as much as you would with mutual funds. Some annuities may let you take advantage of a growing market or rising interest rates, but you aren’t likely to see your money grow as much as if you invested directly in the market with a mutual fund.

Mutual funds offer instant portfolio diversification and lower fees, but they also allow you to realize significant growth when the market (or a sector thereof) is on the rise. However, they also have the potential of lower earnings with the risk of losing money. This lack of security may be a turn-off, particularly for those seeking reliable retirement income.

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 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.

Photo credit: ©iStock.com/DragonImages, ©iStock.com/Newbird, ©iStock.com/utah778