Deciding where to put your hard-earned money can feel overwhelming. From stocks and bonds to bank CDs and 401Ks, you have plenty of choices. But how can you navigate the complexities of each option to make the best choice for your financial future?
Take fixed annuities and mutual funds, for example. Both offer ways to grow your savings. But one is an insurance product while the other is an investment option. One comes with principal protection subject to surrender charges, while the other offers potentially higher yields. One provides guaranteed income payments and withdrawal limits, while the other is a liquid asset.
Keep reading to learn about the pros and cons of fixed and fixed-indexed annuities vs. mutual funds along with what sets them apart.
Note: All guarantees are subject to the claims-paying ability of the insurer.
Mutual Funds vs. Fixed Annuities at a Glance
Fixed annuities provide guaranteed income for retirement while mutual funds can provide dividends and capital gain distributions at any age, including during retirement. Let’s go over their main features.
What Is a Fixed Annuity?
A fixed annuity is an insurance product that provides guaranteed income payments in exchange for a lump sum or premiums paid over time. Your contributions to an annuity grow on a tax-deferred basis until the account is annuitized. At that time, the value is transformed into a stream of payments according to your contract. Payments may last for a term like 10 years or for the rest of your life.
In terms of timing, you can choose an immediate or deferred fixed annuity. An immediate annuity starts paying you back as it says, “immediately,” so it works well if you’re entering retirement and want a secure income stream quickly. A deferred annuity is credited with interest for a term, like five or 10 years, or until a specified age (e.g. 80 years old) before beginning payouts.
You can also choose how the account grows before annuitization. Fixed annuities grow at a rate set by the insurance company. Fixed-indexed annuities grow at an interest rate that is based on the performance of an index like the S&P 500.
Both types of annuities provide principal protection, subject to surrender charges and market value adjustments. This means your account’s value won’t decrease because of poor market performance.
Note: All guarantees are subject to the claims-paying ability of the insurer.
Pros and Cons of Fixed Annuities
| Pros | Cons |
| Provides guaranteed income payments for a specific term. | Annuity accounts may have lower growth rates than investment accounts. |
| The account grows tax-deferred and a portion of income may be exempt from taxes. | Deferred annuities lack some liquidity, and accounts can charge surrender fees for some withdrawals. |
| Many contract and rider options to adapt to different situations. | Annuity types and contract options can be confusing for first-time buyers. |
| Fixed and fixed-indexed annuities offer a minimum rate of interest. | Annuities may grow at a slower rate than the market. |
| Fixed annuities do not charge management fees or fund fees on the principal. |
Note: Riders may be subject to eligibility and underwriting requirements, additional premium requirements and/or minimum or maximum coverage amounts. Availability and rider provisions may vary by state.
What Is a Mutual Fund?
A mutual fund is a portfolio of investments owned by a pool of investors. Investors purchase shares of the mutual fund, and the fund’s managers decide which securities the fund should invest in according to an overall strategy. This gives investors like you access to a diversified portfolio without having to research each stock.
There are many types of mutual funds. Some funds are meant to provide steady cash flow through dividends or fund distributions when the fund gains value. Others focus on high-growth sectors. Different types of funds are better suited for different investors. For example, someone already in retirement may want a fund that pays dividends, while a younger investor might want to maximize their potential capital gains.
When looking at mutual funds, pay attention to the total return figure. This represents the total growth across all investments in the mutual fund over different periods of time. While individual stocks can be volatile, well-managed mutual funds will typically show steady growth.
Pros and Cons of Mutual Funds
| Pros | Cons |
| The portfolio is managed by professionals who strategize investments. | Investments can lose value depending on market performance. |
| Receive distributions in multiple ways including through dividends or the fund earning capital gains and distributing some of the increase to fund holders | Distributions and capital gains are taxed upon realization and the timing can be unpredictable. |
| A diversified portfolio can reduce risk. | Mutual funds don’t offer guaranteed returns or guaranteed income. |
| Mutual funds typically are subject to two annual fees – a management fee charged by the fund manager, and a management fee charged by your financial planner. |
Similarities Between Fixed Annuities and Mutual Funds
Fixed annuities and mutual funds share some similarities. They can both provide different types of retirement income and they can grow over time.
- Retirement income: Both annuities and mutual funds can provide income in retirement. Fixed annuities can provide a steady stream of guaranteed income payments through the process of annuitization. With a mutual fund, you can set up a Systematic Withdrawl Plan (SWP), which enables you to withdraw a fixed amount of money regularly from the fund as long as the principal amount invested in the fund has not dropped in value.
- Account growth: Generally speaking, fixed annuities and mutual funds can grow in value over time. With a fixed or indexed annuity, the account will grow with a fixed interest rate set by the insurance company or based on a market index. Mutual funds can grow as underlying investments increase in value, however, they can also lose value based on market changes.
Differences Between Fixed Annuities vs. Mutual Funds
Here are a few differences between mutual funds and annuities:
- Investment vs. insurance product: While annuity accounts can grow in value like investment accounts, annuities are insurance products typically sold by insurance agents. Mutual funds are investment products sold by security brokers or investment advisors.
- Protection of principal: Fixed and fixed-indexed annuities provide guaranteed minimum interest rates and protection against market losses. Mutual funds can’t offer this.
- Guaranteed income payments: Only annuities offer guaranteed retirement income. The insurance company is obligated to pay you for a term or the rest of your life according to the contract.
- Liquidity: During both the accumulation and distribution phases of an annuity you can’t withdraw funds without incurring charges unless it’s allowed by the contract. In contrast, you can fully withdraw from a mutual fund at any time by selling all your shares, though you’ll pay taxes on any capital gains. In either account, you may also pay a penalty if the fund or annuity was part of a qualified account like a 401(k) or IRA.
- Taxes: Annuities grow tax-free, while mutual funds are subject to annual taxation if the fund itself sells shares for a profit or receives dividends during a year. This is true even if the investor hasn’t sold their share of the fund. Mutual fund taxes typically include taxes on dividends and earnings while the investor owns the mutual fund shares, as well as capital gains taxes when the investor sells the shares. The tax rate and amount owed depend on the type of distribution and other factors. Annuities, on the other hand, are only taxed upon withdrawal or distributions from an annuitized account and are taxed as normal income according to your tax bracket.
- Riders: Riders modify annuity contracts to provide benefits in certain circumstances. Some options include death benefits, long-term care, guaranteed minimum income benefits, or return of premium riders. Mutual funds are not contractual and therefore don’t offer riders or rider benefits.
Note: Any reference to the taxation of annuities and mutual funds in this material is based on Annuitiy.com’s understanding of current tax laws. We do not provide tax or legal advice. Please consult a qualified tax professional regarding your personal situation.
Are Fixed Annuities Better Than Mutual Funds?
Annuities and mutual funds can be helpful financial tools in different situations. An annuity is a good choice if you want to contribute to an account that earns interest, and then converts to a stream of payments. You don’t have to worry about poor market conditions with a fixed or fixed-indexed annuity since they provide a guaranteed minimum interest rate.
How Annuities and Mutual Funds Can Work Together
You don’t have to choose between mutual funds and annuities. In fact, the two can complement one another in a retirement strategy. Since an annuity offers guaranteed payments, you can rely on one for income during a period of time or even the rest of your life. Having an annuity in retirement gives you a level of security that a mutual fund might not offer.
At the same time, you can invest money in a mutual fund to take advantage of higher growth potential. You could find a mutual fund focusing on tech startups or large companies with strong performance. The liquidity of a mutual fund is also useful if you need to withdraw for unexpected expenses in retirement.
Learn About the Right Annuity for You
Annuities and mutual funds both play roles in a diversified retirement plan. Fixed annuities provide stable income with lower risk, while mutual funds can offer higher returns and increased liquidity. If you’re thinking about starting an annuity, reach out to a licensed agent to see how having one can support your retirement goals.
