While mapping out your financial future, you may face several choices that could affect your retirement journey. For instance, you could choose the path that depends on steady, predictable income, or you could pick the option that’s built on investments and depends on growth.
Many pre-retirees find themselves at this crossroads when choosing between an annuity vs. mutual fund. Each has unique advantages: annuities may offer guaranteed income, while mutual funds boast the potential for market gains.
Here’s a closer look at annuities and mutual funds to help you confidently navigate the right route for your needs and retirement goals.
Annuities: The Path to Predictable Income and Security
Annuities offer guaranteed lifetime income, reducing the fear of outliving your money. You can choose from a few types of annuities.
Fixed Annuity
A fixed annuity offers a guaranteed return on your investment for a specific period.
Index Annuity
An index annuity provides income based on the respective index’s performance.
Variable Annuity
A variable annuity invests your contributions into different funds, so the payout depends on the funds’ performance.
Advantages of Annuities
Annuities’ dependable nature underscores why people are purchasing them at record levels. General benefits include:
- Guaranteed returns for a specific period.
- Option of lifetime income.
- Principal protection with minimal risk of loss.
- Tax-deferred growth on the principal balance.
- Better protection from market losses.
- Flexibility in choosing when payments start.
- Highly customizable with death benefits and other options.
Potential Drawbacks of Annuities
Annuities offer many benefits, but they can come with some drawbacks:
- They tend to have higher minimum investment requirements and upfront charges.
- Fixed annuities may trail inflation due to their stated interest rate and can have hefty penalties for early withdrawal.
Mutual Funds: The Road to Growth and Opportunity
Mutual funds are baskets of securities professional fund managers assemble based on each fund’s objectives. By purchasing fund shares, you experience the underlying securities’ gains or losses. Most mutual funds invest in significant classes, such as stocks, bonds, money market securities, etc.
Mutual funds are typically ideal if you want to invest in a diversified portfolio of market-based securities without the inclination or time to monitor each one’s performance. They allow you to take advantage of market gains but come with the risk you could lose your initial investment.
You can choose from a few types of mutual funds.
International Funds
International funds primarily invest in overseas firms.
Index Funds
Index funds track major indices, such as S&P 500.
Large-Cap Stock Funds
Large-cap stock funds invest in corporations with large market capitalization.
Small-Cap Stock Funds
Small-cap stock funds invest in companies with smaller market capitalization.
Advantages of Mutual Funds
Mutual funds offer inherent diversification, spreading risk across several investments simultaneously. They minimize the impact of poor stock or bond performance. Additional benefits of mutual funds include:
- Highly tradable and liquid investments.
- Investors can gain exposure to a broad portfolio with a smaller investment.
- Some Mutual Funds allow for automatic reinvestment of dividends and capital gains, which can help grow an investment over time. Compounding through reinvestment over a long time horizon can amplify growth potential.
- There can be the stress of choosing the right mutual fund. Consider adding professionally managed by portfolio managers who analyze and adjust holdings based on market conditions aiming to optimize returns and manage risk.
Potential Drawbacks of Mutual Funds
As with any financial product, mutual funds can come with some drawbacks:
- Because mutual funds are professionally managed, fund managers can charge fees, affecting your earnings.
- When you invest in mutual funds, you have little to no control over the securities in your portfolio, which could result in dividends or sales activity that triggers taxes.
- The returns on mutual funds aren’t guaranteed, and you can lose your original investment if all stocks in the fund tank.
Deciding between an Annuity vs. Mutual Fund
Whether you choose annuities, mutual funds, or a mix of both depends on your objectives, risk tolerance, and what matters most to you.
Tax Considerations
One key distinction between mutual funds and annuities is their tax treatment. Annuities offer tax-deferred growth, meaning you don’t pay taxes on your earnings until you withdraw them. The capital gains and dividends of mutual funds in a Roth or traditional individual retirement account (IRA) are reinvested into the fund, offering the same tax deferral as annuities.
However, if you have mutual funds outside a qualified account, you may have to report capital gains and income on federal tax filings.
Risk and Security
Insurance companies back annuities and protect your principal. Even though insolvency risk exists, you have less risk of losing your money (depending on the type of annuity you choose). On the other hand, volatile market conditions can lead to losing your investment in mutual funds.
Guaranteed Income
You may enjoy guaranteed income by choosing the right annuity and payout option. Annuities can provide income safety, reducing the fear of running out of money in retirement. Mutual funds can offer excellent returns, but past performance isn’t an indicator of future earnings.
Returns
In terms of returns, annuities are more conservative. While you typically enjoy principal protection and guaranteed returns with annuities, you may lose out on mutual funds’ potential higher returns. In contrast, mutual funds may provide higher returns, but you have no principal protection.
Liquidity
Mutual funds are liquid, allowing you to sell shares to meet emergency needs. However, if the mutual funds are held in a retirement account, such as an IRA, you may be subject to early withdrawal penalties for taking the money out before reaching 59½. Annuities are less liquid, whether in or out of a retirement account. Traditional annuities may charge hefty penalties for early withdrawals above a specific amount.
Fees and Expenses
The guarantees of annuities come at a cost. You may be subject to higher upfront fees, administrative costs, and mortality expenses, affecting your total return. Even though mutual funds have costs, they tend to be less expensive than annuities.
Finding Your Ideal Path to Retirement
As you stand at the crossroads of your financial future, remember that both roads—annuities and mutual funds—offer unique advantages depending on your goals. Whether you seek the safety of guaranteed income or the excitement of potential growth, your path will shape your journey toward retirement.
At Bankers Life, we’re here to guide you down the road that’s right for you. Contact a representative today and let us help you navigate your way to a secure and fulfilling retirement.
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Insurers and their representatives are not permitted by law to offer tax or legal advice. The general and educational information here supports the sales, marketing or service of insurance policies. Based upon individuals’ particular circumstances and objectives, they should seek specific advice from their own qualified and duly-licensed independent tax or legal advisors.
Bankers Life Securities, Inc., Bankers Life Advisory Services, Inc., and their representatives do not provide legal or tax advice. Each individual should seek specific advice from their own tax or legal advisors.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.
Bankers Life is the marketing brand of various affiliated companies of CNO Financial Group including, Bankers Life and Casualty Company, Bankers Life Securities, Inc., and Bankers Life Advisory Services, Inc. Non-affiliated insurance products are offered through Bankers Life Securities General Agency, Inc., (dba BL General Insurance Agency, Inc., AK, AL, CA, NV, PA).
Securities and variable annuities offered through Bankers Life Securities, Inc. Member, FINRA/SIPC (dba BL Securities Inc., AL, GA, IA, IL, MI, NV, PA). Advisory products and services offered by Bankers Life Advisory Services, Inc. SEC Registered Investment Adviser (dba BL Advisory Services, Inc., AL, GA, IA, MT, NV, PA).
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