Annuity Vs. Mutual Funds

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Many investors weigh annuities vs. mutual funds for retirement planning. Considerations include risk tolerance--how comfortable you are with potentially losing your investment--and short- and long-term investment goals. Fees and the taxes also play a role.

Types

  • An annuity is an agreement with an insurance company. You pay a fee up front and receive structured payments for the agreed-upon period of time. The two primary types are deferred and immediate annuities. In a deferred annuity, you hold off on receiving payments for a specified period of time, usually until retirement. In an immediate annuity, you begin receiving payments right away, which is usually a lesser amount than if you defer it.

    Mutual funds are purchased as shares and you make or lose money based on how well the fund's investments perform. A mutual fund usually invests in stocks, bonds or other various short-term investments.

Benefits

  • The primary benefit to investing in fixed annuities is that your money and profits are secured. As long as you live for the length of your annuity, you will see those payments and profits. In the event of premature death, some annuities will allow you to name a beneficiary who is eligible to receive your annuity payment for the duration of the contract.

    The primary benefit of a mutual fund is that it is possible to see significant short-term profits. Mutual funds are a risk based investment, if the fund invests well, all of their investors may see substantial profits.

Disadvantages

  • The primary disadvantage of mutual funds is the risk involved. Your money is not guaranteed to be returned and in some cases you may lose everything. Another disadvantage is that you have little or no control over how and where your money is being invested.

    A primary disadvantage to investing in annuities is lack of short-term income potential. Many annuities also have substantial penalties for withdrawing your money early, and some have yearly maintenance fees that effect your overall return.

Taxes

  • Mutual fund earnings are taxed several ways. You must pay taxes on any dividends received each year, and you must also pay capital gains tax when you sell your shares of the fund. In addition to those basic investment taxes, you may also be required to pay taxes on the fund's capital gains each year.

    Annuities are taxed differently. In a qualified annuity, which is similar to a 401k, your earnings are not taxed till withdrawal. Qualified annuities are purchased with before-tax dollars. Nonqualified annuities are purchased with after-tax dollars. The primary benefit is that if you withdraw your funds early, you will not be subjected to income tax in addition to the assessed penalty.

Considerations

  • If you are looking for a safe and secure long-term investment, invest in a fixed annuity. If your goal is to see a significant short-term profit, look at a mutual fund. If you seek an investment that is potentially profitable in both the short- and long-term, consider a mutual fund.

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