Annuities and money market accounts are probably some of the safest investment vehicles on the market. They are among the lower risk investment options. But that also means returns won’t be enormous. For instance, as of early 2013, a money market account interest rate hovered around 1 percent. An annuity can earn higher rates depending on its type. And because these investments are less risky, they are often featured in retirement plans.
What Is an Annuity?
An annuity is savings vehicle that guarantees income upon retirement. An investor pays into the plan, which is often offered by an insurance company. After time passes the invested money are given back in installments. For instance, an investor can ask that after the annuity matures they receive a check every month or quarter or possibly in one lump sum. The money invested also grows over time based on the type of annuity chosen. An investor usually can't access the annuity until they are 59 1/2 years old.
Types of Annuities
Annuities are generally either fixed or variable. As you might have guessed, a fixed product allows the investor to know exactly what they’ll receive when the annuity pays out. The investor would pay into a CD-like product with set payments to for the life of the annuity. A variable annuity functions more like a mutual fund. The money is invested in a variety of mutual funds offered by an insurance agency and the investor's money is subject to stock market gains or losses. These mutual fund offerings are considered more stable in that they are professionally managed accounts with the comfort of stock diversity built-in.
What Is a Money Market Account?
A money market account is considered the boring approach to investing savings. Basically, the account set up at a bank, which offers a fixed rate of return that is usually higher than the standard interest rate of a savings account. The future retiree just needs to maintain a minimum balance -- $10,000 or whatever the bank limit is -- and can only use the account sparingly, say write four checks a month on the account. These criteria are necessary for the bank offer the higher interest rate. MMAs are considered the halfway point between the higher-yielding yet illiquid certificate of deposits and a standard savings account.
The Pros and Cons of a MMA
MMAs allow investors to earn interest on money available to them now. Earnings usually fall in the single-digit percentages. But the money is safe from the volatility of the stock market. There are fees involved in MMAs, which can take a bite of your interest-based earnings. For instance, if an investor sinks $5,000 into an account with a 3 percent return than they can expect earnings of $150 a year. However, the fees could be about $30 or about 20 percent of the earnings.
Pros and Cons of an Annuity
An annuity is shielded from taxes. An investor can stash as much cash as they want without having to pay taxes going in. The growth of the money is tax free. Taxes come into play only when the money is taken out, at which point the payments are taxed like income. Annuities often have higher fees than other investment vehicles. The insurance agent selling the annuity can get as much as a 10-percent cut and a variable annuity could charge fees of upwards of 3 percent per year. There is also something called a surrender charge, which an investor faces when taking money out early. Take a buyer-beware approach before selecting an annuity as there are annuities on the market called direct-sold annuities, which are sold by financial institutions as opposed to insurance salesman.
- Comstock Images/Comstock/Getty Images