Annuities Vs. IRA Mutual Funds
When trying to make a decision between investing in annuities vs. IRA mutual funds, you must first define your financial objectives. Each of these financial vehicles has its own particular advantages and disadvantages that can be adapted to the particular needs of each investor.
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Definitions
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An annuity is a financial product offered by an insurance company that is designed to provide income for retirement. Annuities can provide fixed income, like bank CDs, variable income based on market changes and have other options, such as lifetime payments. Withdrawals can start either immediately or at some specified future date.
Mutual funds are investment vehicles set up by independent management companies. They can consist of various combination of stocks, bonds and money market accounts. Mutual funds are not set up like annuities to provide regular, systematic payments. Withdrawals from IRA mutual funds must be in accordance with the terms of the IRA, otherwise, there will be substantial penalties.
Both IRA mutual funds and annuities are subject to significant IRS penalties for withdrawals made prior to age 59 1/2.
Investment Options
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Annuities fall into two categories: fixed and variable. In a fixed annuity, the return is guaranteed at a fixed percentage for a certain time period and is periodically reset to changing market conditions. With a variable annuity, the funds are invested in a family of mutual funds that are provided by the insurance company. The annuitant does not have the option of selecting any mutual fund he wants; he can only choose from the ones offered by the insurance company.
On the other hand, an investor in mutual funds can select any fund that he wants. He has the choice of investing in any mutual fund available in the market that suits his risk profile.
While there are maximum amounts that can be invested each year into an IRA mutual fund, there are no limitations on the amount of money that can be placed into annuities.
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Options
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The owner of an annuity can elect to receive payments for a specified period of time or can opt to receive payments for his lifetime for an additional fee. This option is not available with mutual funds. If the investor is making withdrawals from his mutual fund account for retirement income, he can only withdraw as much as his investment in the fund. He, therefore, has the risk of running out of money and outliving his investment.
Annuities also have the option of continuing to make payments to a spouse after the annuitant has died or make provision for long-term care. Mutual funds do not have these options.
Taxes
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One of the advantages of annuities is that the income earned on an annuity is tax-deferred, and taxes are not paid until monies are withdrawn. This makes an annuity similar to the tax-deferral aspect of an IRA or 401k. However, when withdrawals start, the investor will pay taxes at the ordinary income rate, not the capital gains rate.
While income gains on mutual funds are normally taxed at capital gains rate as they accrue, putting a mutual fund inside an IRA or 401k will create a tax-deferred situation. The investor will not pay taxes until he begins to make withdrawals and, even then, will only be paying at the capital gains rate.
Fees
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Both annuities and mutual funds have charges for sales commissions, management fees and administrative costs. In some cases, these fees are collected up-front as a sales commission and deducted from the initial investment, while, in other types, the charges are collected over the life of the investment.
No-load mutual funds do not collect a sales commission up-front, but, instead, will charge a somewhat higher annual management fee, and may also have a back-end charge for withdrawals made with a specified time period. This back-end charge will be very high for the first year but will scale down over the years to zero.
Annuities have a surrender charge that is very high for withdrawals made with the first seven to 10 years of the annuity. A typical charge for a first year withdrawal might be as high as 10 percent, but will gradually reduce each year.
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