Annuities and mutual funds have significant differences when it comes to using them for retirement income. In J. Brendan Ryan’s Cincinnati Enquirer article, “Worried about long-term income? Annuities ease anxiety.,” Mr. Ryan offers up some of the basics of annuity products and tells us how they are different from mutual funds. Do you know what annuity means? In its basic definition, an annuity is just a periodic payment. Life annuities make payments to you for as long as you live. Life insurance companies offer most life annuity products, which are the opposite of life insurance. With the latter, you make periodic payments and then receive a lump sum payout when someone dies. With annuity products, you typically make one lump sum payment and then receive periodic payments for the rest of your life. Each annuity is different though. You can make more than one payment into the product and some people choose to receive payouts over a specific time frame, rather than their whole life.
Fixed annuities guarantee your principal and offer a minimum guaranteed interest rate. We saw in yesterday’s blog that fixed annuities offer the best returns when the market at retirement is lower than the market in which you purchased your annuity. Variable annuities allow you to choose different investment options, or subaccounts, in which you will place your funds. They often do not guarantee all of your principal or a specific interest rate. Your return is based on the returns of all of your subaccounts, which are structured similarly to mutual funds. Although this particular part of a variable annuity is similar to a mutual fund, there are important differences between the two that make annuities a great way to ease the anxiety that can come when you are trying to finance your retirement.
With an annuity, credited dividends and gains are tax-deferred until you start withdrawing your money. That isn’t the case with mutual funds. Although the gains are taxed at ordinary income rates rather than capital gains rates with annuities, as long as you leave your money in the annuity as long as planned, the tax deferral benefits outweigh annuity costs. Unlike mutual funds, annuities guarantee lifetime income. This is one of greatest benefits of annuities and the main reason that many people, the government included, tout annuities as a good vehicle to help with retirement. Your income is based on your age, accumulation, and the options you choose with your annuity. Some people even opt for income guaranteed over a spouse’s lifetime as well.
The third difference between variable annuities and mutual funds is the death benefits offered with variable annuities. Your heirs can get death benefits paid that are worth more than the account value at the time of death. Changes can be made to annuities between the accumulation and drawdown phases, including switching from a fixed to a variable annuity. During these uncertain economic times, annuities are a good way to manage any worries you have concerning retirement. Your retirement income is guaranteed, death benefits are often available, and you get tax-deferral benefits not available with mutual funds. Speak with an expert if you have any questions about annuities and their potential benefits for retirement.
Written by Rachel Summit