Differences Between an Annuity vs a Mutual Fund

Annuity

An annuity is a product that pays you back over time. It provides a set payment every month until the contract expires. It is also a good way to generate a steady stream of income in retirement. There are two types of annuities: fixed and variable. With a fixed annuity, you receive the same payment each month for the life of the contract. With a variable annuity, the payments you receive can vary based on the performance of your investments.

How It Works

When you buy an annuity, the money you give to the company is invested in different types of securities, such as stocks and bonds The company then promises to pay you back a set amount of money each month or year, depending on the type of annuity you purchased.  Many people use annuities as a means of generating steady income in their retirement years.

Mutual Funds

A mutual fund is an investment account that allows you to pool your money together with other investors and buy shares in many different types of securities, such as stocks, bonds and money market funds.  When one investor purchases a share of the mutual fund, they become a part of the pool and own a small piece of each security that the mutual fund owns. It pools your money together with other investors and pays different returns depending on the performance of the securities in the fund. 

How It Works

Mutual funds are managed by professional money managers who make all the investment decisions for the fund.  The goal is to buy securities that will perform well over time and provide a return on investment that is higher than what you would get if you invested in individual securities on your own. 

Differences Between Annuities and Mutual Funds

There are a few major differences between annuities and mutual funds. 

Product

The main difference between annuities and mutual funds is that annuities are insurance products, while mutual funds are investment products. 

Payments

An annuity is a contract that guarantees you will receive a specific payment for the lifetime of the contract. This payment cannot change in amount or frequency.  Mutual funds can vary in value depending on how well the securities investments in the fund perform. This means the payments you receive from a mutual fund can change over time. 

Fees

Annuities typically have higher fees than mutual funds. This is because annuities are a more complex product and need to be managed by professionals. 

Taxes

When you sell your shares in a mutual fund, you will have to pay taxes on the capital gains.  When you receive payments from an annuity, you will not have to pay taxes on the income. 

Death Benefits

If you die while owning shares in a mutual fund, your beneficiaries will receive the value of the shares at the time of your death.  If you die while owning an annuity, the payments you receive will continue to your beneficiaries. 

Pros and Cons of Each Option

Annuity Pros

  • You receive a set payment each month or year depending on the type of annuity for the life of the contract. This is very helpful if you need regular income in retirement and want a secure way to get it.
  • Your payments cannot change in amount or frequency. This can be helpful if you are worried about unpredictable market fluctuations
  • The fees on an annuity are typically lower than those on a mutual fund because the product is simpler and does not require active management by professionals or commissions to brokers. 

Annuity Cons

  • You will not have any control over the investments in the annuity. The company that you buy the annuity from will invest your money in a variety of securities, but you will not be able to choose which ones.
  • If the market performs poorly, your payments from the annuity may be lower than if you had invested in a mutual fund.
  • Annuities are taxed as income, so you will have to pay taxes on the payments you receive.

Mutual Fund Pros

  • You have a lot of control over the investments in a mutual fund. This allows you to invest in a variety of securities and choose those that you think will perform well over time.
  • The fees on a mutual fund are typically lower than those on an annuity.
  • Mutual funds are not taxed as income, so the payments you receive are not taxed.
  • If the market performs poorly, your mutual fund may lose value, but you will not have to pay taxes on any losses.
  • Your beneficiaries will receive the value of your shares at the time of your death if you die while owning them.

Mutual Fund Cons

  • Mutual funds are more complex products than annuities and require active management by professionals. This can lead to higher fees.
  • You may experience losses in a mutual fund if the securities in the fund do not perform well.
  • The market may perform well, but the mutual fund could lose value over time. In this case, your beneficiaries will not receive anything when you die while owning these shares.

Things to Consider When Investing in Both

When deciding between purchasing an annuity or investing in mutual funds, one option is not better than the other.  It all depends on your financial goals and how much risk you are willing to take with your retirement savings. 

Stream of Income

If you want a steady stream of income, an annuity can be a good choice for you because it provides a guaranteed payout every month until the contract ends.  However, if you have a longer time horizon for your investments and are willing to take on more risk, a mutual fund may be a better option because it has the potential to provide a higher return on investment. 

Investment Flexibility

One of the benefits of investing in a mutual fund is that you have the flexibility to get your money out at any time.  This is not the case with annuities, which typically have penalties for withdrawing your money before the contract expires. 

Liability

When you invest in a mutual fund, you are investing in a pooled fund managed by professional money managers.  This means that you are not responsible for the individual securities in the fund and are not liable for any losses they may experience.  When you purchase an annuity, you are purchasing a contract with an insurance company.  This means you are liable for any losses the insurance company experiences with the annuity. 

Tips on Deciding Whether or Not to Invest in Either One

When making the decision between an annuity and a mutual fund, there are several factors you should consider.  First, you need to ask yourself how much risk you are willing to take with your retirement savings.  If you are uncomfortable with the idea of losing money, an annuity may be a better choice for you.  Second, you should consider your financial goals.  Do you want a steady income stream in retirement, or are you looking for a higher return on investment?  Lastly, you should consult with a financial advisor to get their opinion on which option is best for you. They will be able to help you make an informed decision based on your individual needs and goals.

The Bottom Line

Annuities and mutual funds are both good options for retirement savings, and it is important to consider your individual needs and goals when deciding which one is right for you.  If you want a guaranteed stream of income, an annuity may be a good choice. If you want the potential for a higher return and are willing to take on more risk, mutual funds may be better.  Either way, it is important to consider your financial situation and how much risk you can handle before making a decision. 

The biggest difference between an annuity and a mutual fund is that an annuity provides a guaranteed stream of income, while a mutual fund does not. In annuities, you cannot withdraw your money without penalty until the contract expires.
When you purchase an annuity, you are purchasing a contract with an insurance company. This contract guarantees a certain payout each month until the contract expires.
When you invest in a mutual fund, you are investing in a pooled fund managed by professional money managers. This means that you are not responsible for the individual securities in the fund and are not liable for any losses they may experience.
The biggest benefit of an annuity is that it provides a guaranteed stream of income in retirement. This is a great option for retirees who are looking for a steady income stream.
The biggest benefit of a mutual fund is that it has the potential to provide a higher return on investment than an annuity. This is a great option for retirees who are looking to grow their retirement savings.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.