Should you choose an annuity or a mutual fund for your retirement income? Many Americans, including Veterans, have long turned toward annuities to convert their retirement nest eggs into guaranteed lifetime income streams when they stop working. However, mutual funds are also popular because of their low capital gain tax and simplicity.
Explore the differences between annuities and mutual funds so you can make the right decision for your financial plan.
Offered exclusively by insurance companies, an annuity is a financial product that provides a predictable cash flow to its holder, often used to supplement retirement income. In exchange for a lump sum payment or series of payments, the insurer agrees to make periodic payments to the annuity holder, either for a fixed period or for the holder’s lifetime.
Annuities come in different forms, such as fixed, variable, and indexed, each with unique investment strategies and risks.
Fixed annuities pay an established rate of return. An insurance company guarantees the return, and you get your money back plus interest if you hold the fixed annuity for a specific period (usually ten years).
Fixed-rate annuities are good options for people who want to make sure their principal is protected. They may not be ideal for investors who are looking for high returns.
Variable annuities pay market rates. The sub-accounts typically represent a mutual fund wrapped in a deferred-tax insurance product. Payouts for a variable annuity can be guaranteed for life, regardless of the investment earnings. You can also include a death benefit payout clause. However, the amounts fluctuate over time, depending on the performance of the underlying assets in the market.
Variable annuities have more in common with mutual funds, which is why they are typically compared to each other.
Indexed annuities, also known as equity-indexed annuities, provide returns based on the performance of a specified market index, such as the S&P 500. They combine features of both fixed and variable annuities by offering a guaranteed minimum return with the potential for higher returns tied to the index.
While gains can grow when the index performs well, there is typically a cap on maximum returns, and losses are limited as the principal is generally protected from negative index performance. Indexed annuities are often chosen for their balance of growth potential and downside protection, making them a popular choice for those seeking income with moderate risk.
Annuities offer several advantages:
Annuities have several potential disadvantages, which could impact their suitability for some individuals:
A mutual fund is an investment solution that pools money from many investors to purchase a diversified portfolio of securities, such as stocks, bonds, or other assets.
Managed by professional fund managers, mutual funds allow individual investors to access a broad range of investments without needing extensive market knowledge or large amounts of capital. The fund’s returns, minus management fees, are passed back to the investors based proportionally on the number of shares they own.
There are various types of mutual funds, each with distinct objectives and risk levels, including the following:
Mutual funds offer several advantages that make them appealing to a wide range of investors:
Mutual funds come with certain disadvantages that investors should consider:
An annuity is a good option for those who want to protect their assets or who are looking for guaranteed income. If you want to leave your money alone to grow, while guaranteeing it’ll be there with interest when you need it, then an annuity might be the right choice for you. Additionally, if you’re concerned about market fluctuations and feel that investments are too risky for you at this stage of life, an annuity could also be worth considering.
The guaranteed income through annuities makes them an attractive option in the annuity vs. mutual fund comparison.
If you want to invest in a diversified portfolio of stocks and bonds and don’t have the time or inclination to closely monitor the performance of your investments, then mutual funds may be the way to go. They’re also a good option if you want to invest in a specific sector or industry because they enable you to do so without researching individual companies yourself.
Mutual funds also allow investors with different risk tolerances (or time horizons) an opportunity for investment diversification within their portfolios. Lower-risk investors can select low-risk mutual funds while those willing to take on more risk could choose higher-volatility mutual funds.
Choosing between an annuity and a mutual fund for your retirement goals is a big decision. Everyone’s financial situation is different, and there is no right or wrong answer when you are thinking about your options. You should consider some key factors, such as:
Talking to a trusted financial expert about the specifics of your situation can help you make this decision. There’s no substitute for personalized advice from someone with direct knowledge and experience in helping military servicemembers and Veterans prepare for retirement.
If you’re thinking about a military life insurance policy or just have questions, contact AAFMAA today at 877-398-2263 or get a free quote for coverage right now.
This article was originally published December 13, 2022.