Mutual funds and annuities are common investment options. Mutual funds are combinations of several types of investments, including stocks, bonds and other securities. Annuities are insurance products that provide regular returns for the holder. Fixed annuities have set returns, whereas variable annuities have returns that depend on the performance of the portfolio.
The ways you are taxed on gains from annuities and mutual funds are completely different. The money in an annuity grows tax-deferred until you start withdrawing it, but at that point, the gains are taxed as regular income. Mutual fund gains are treated as long-term investments if they are held for more than a year before you sell them. Long term capital gains are taxed at a much lower rate than regular income, so mutual fund gains are typically taxed at a much lower rate than gains on annuities.
With a mutual fund, you have the freedom to withdraw money whenever you want to do so as long as the fund is not held within a qualified retirement plan, such as a 401(k) or an IRA. In addition to getting the dividend payments and capital gain distributions, you may sell the shares at your discretion. This makes it easy for you to turn them around for quick cash. Annuities, on the other hand, have more restricted withdrawal rules. For one, you will have to pay a 10 percent penalty if you withdraw any money before you reach age 59 1/2, given that annuities are retirement accounts. Many annuities also have surrender charges, which are fees you pay if you withdraw money before a period of time has passed -- usually six to 10 years. With an annuity, you have several choices on how you will receive the money when you begin withdrawals, but in most cases, you will take monthly distributions.
Potential for Loss
The value of your shares in a mutual fund can decrease if the fund managers pick bad investments or the stock market goes down. Therefore, you have the potential to lose money. Annuities, on the other hand, often offer insurance that guarantees that you will never lose the money you initially invest. In addition, some annuities allow you to purchase a death benefit that guarantees that a particular amount of your annuity will pass on to the beneficiary you name.
Mutual funds and annuities both have associated management fees. The fees for mutual funds are on average 1 percent lower than those of annuities. In addition, annuities tack on extra fees, like those for insurance, death benefits and long-term care benefits. These fees can significantly cut into the profits from an annuity. In exchange, the annuity investor receives more protection from risk.
If you want to switch your money from one mutual fund or annuity to another, the process has very different financial repercussions. With a mutual fund, you must sell your shares in your current mutual fund and buy shares in another, taking the capital gains on your investment and paying all of the fees again, if any. With an annuity, you may complete a tax-free exchange -- sometimes called a 1035 exchange because it is discussed in section 1035 of the tax code. This allows you to transfer your funds from one annuity to another without paying tax on any income at the time of the transfer.
- Bankrate.com: Annuity or Mutual Fund for Retirement?
- Morningstar.com: 403(b) Plans
- U.S. Securities and Exchange Commission: Invest Wisely: An Introduction to Mutual Funds
- U.S. Securities and Exchange Commission: Variable Annuities: What You Should Know
- Fidelity Investments. "What Are Annuities?" Accessed June 12, 2020.
- Internal Revenue Service. "Publication 575, Pension and Annuity Income." Accessed June 12, 2020.
- Ray LaVitre. "20 Retirement Decisions You Need to Make Right Now," Page 261. Sourcebooks, 2014. Accessed June 12, 2020.
- Internal Revenue Service. "Topic No. 409, Capital Gains and Losses." Accessed June 12, 2020.
- Kiplinger. "The Hidden Costs of Variable Annuities and How to Avoid Them." Accessed June 12, 2020.
- Vanguard. "Vanguard Variable Annuities Portfolios by Number." Accessed June 12, 2020.
- Fidelity Investments. "Annuities Available Through Fidelity." Accessed June 12, 2020.
- TIAA. "About the Annuity Cost Savings Tool." Accessed June 12, 2020.