Annuities vs. Mutual Funds
Annuities and mutual funds share some characteristics, but they are completely different financial instruments intended for distinct purposes. An annuity is an insurance product that provides the contract holder with lifetime guaranteed income, whereas a mutual fund is a company that invests shareholders’ money in its portfolio.
- Written By Robert J. Smith, ChFC®
Robert J. Smith, ChFC®
Robert J. Smith is a financial advisor who has earned the CLU®, ChFC®, LIC, CCCC, RIA, AAMS®, CMP® and CMPS® professional designations. Throughout his five-decade career in financial services, Robert has consistently ranked in the top 1% worldwide in insurance and financial services production.Read More
- Edited ByKim Borwick
Kim Borwick is a writer and editor who studies financial literacy and retirement annuities. She has extensive experience with editing educational content and financial topics for Annuity.org.Read More
- Financially Reviewed ByRubina K. Hossain, CFP®
Rubina K. Hossain, CFP®
Certified Financial Planner™ Professional
Certified Financial Planner Rubina K. Hossain is chair of the CFP Board's Council of Examinations and past president of the Financial Planning Association. She specializes in preparing and presenting sound holistic financial plans to ensure her clients achieve their goals.Read More
- Updated: September 13, 2022
- This page features 6 Cited Research Articles
- Edited By
Annuities and mutual funds each have a place in saving and investing. In most cases, however, one may be a better fit than the other. Your risk tolerance and your retirement timeline will determine whether an annuity or a mutual fund fits into your financial plan.
You’ll gain a better idea of which of these financial vehicles suits your goals if you understand the differences between them.
Annuities are contracts issued by insurance companies. They are designed to provide guaranteed income during a person’s retirement years and have the added benefit of nominal growth as compared with equity investments.
The customizable nature of annuities makes them ideal for people who have specific retirement and estate planning goals.
In addition, the tax treatment of annuities appeals to people who want to defer taxes until they reach the age at which they will begin taking distributions.
Whether deferred or immediate, annuities offer people the flexibility to reap the benefits of fixed rates or — if they’re comfortable with a less stable return — to develop a strategy for taking advantage of market gains.
In general, people who buy annuities are attracted to four key benefits:
- Principal protection
- Income for life
- Legacy to beneficiaries
- Long-term care
These reasons for buying an annuity differ from the benefits of mutual funds.
What Is a Mutual Fund?
The United States Securities and Exchange Commission (SEC) defines a mutual fund as “a company that brings together money from many people and invests it in stocks, bonds or other assets. The combined holdings of stocks, bonds or other assets the fund owns are known as its portfolio. Each investor in the fund owns shares, which represent a part of these holdings.”
Note that this definition refers to a mutual fund as a “company” and the fund’s holdings as a “portfolio.” This differentiation is significant because it can be a source of confusion for people who have limited experienced in investing.
To gain a clear understanding of a mutual fund, you can equate it to a product- or service-related business entity, such as Google. When you buy shares of Google, you’re purchasing a piece of the company and its assets. Similarly, when you buy shares of a mutual fund, you are buying a portion of the mutual fund’s holdings.
How Do Mutual Funds Work?
Unlike deferred annuities, mutual funds do not grow tax-deferred unless they are part of a qualified plan, such as an individual retirement account. However, taxable mutual funds do enjoy a “stepped-up” basis at death for tax purposes. This means that when a mutual fund holder passes away, the person who inherits the mutual fund holdings will not owe tax on the inheritance.
Most employer-sponsored retirement plans invest employees’ money in mutual funds.
As the Financial Industry Regulatory Authority (FINRA) notes, “Mutual funds are a popular way to invest in securities. Because mutual funds can offer built-in diversification and professional management, they offer certain advantages over purchasing individual stocks and bonds. But, like investing in any security, investing in a mutual fund involves certain risks, including the possibility that you may lose money.”
- Professional investment management
Returns from mutual funds are distributed differently from any returns one would receive from an annuity. Annuity holders receive payouts as a series of regular payments or, in many cases, as a lump sum at the time they become eligible to cash in their annuity.
In contrast, according to FINRA, mutual funds give you the option of receiving “distributions in cash or having them automatically reinvested in the fund to increase the number of shares you own.”
Profits from the fund’s dividends and interest are called “income distributions,” and those from the fund’s sales of shares are called “capital gains distributions.”
- Capital gains
- Sales of fund shares
The performance of a mutual fund is measured by the increase or decrease in the total market value of the fund’s shares.
Like annuities, mutual funds exist in a variety of categories, with each category offering unique benefits. Mutual funds also carry fees, similar to certain types of annuities, which vary depending on the type of fund, and some even charge penalties for early withdrawals.
Index Funds & Income Funds
Guaranteed lifetime income is the primary goal for people who buy annuities, whereas the objectives for people who invest in mutual funds range from aggressive growth to guaranteed income.
The overlap in these goals naturally leads to overlap in the ability of annuities and mutual funds to achieve these goals.
For example, index funds — one category of mutual funds — are similar to index annuities in that they align with a stock index, such as the S&P 500. Expenses are lower, so these funds appeal to investors who want growth opportunity without excessive management and administrative fees, also known as “expense ratios.”
This is similar a client choosing an indexed annuity for the opportunity to benefit from market gains without the risk of losing money.
Likewise, income funds are similar to income annuities, which are intended to provide a steady cash flow to the contract holder in retirement. The value of income funds can increase, but growth for this type of mutual fund is conservative and most suitable for retirees and people with low risk tolerance.
Once you understand the basic differences between annuities and mutual funds, you are better prepared to plan for your retirement years. If you are already in your retirement years, providing yourself with an immediate income may be a priority for you. No matter your timeline, your financial goals will determine which financial vehicle is suitable for you.
6 Cited Research Articles
Annuity.org writers adhere to strict sourcing guidelines and use only credible sources of information, including authoritative financial publications, academic organizations, peer-reviewed journals, highly regarded nonprofit organizations, government reports, court records and interviews with qualified experts. You can read more about our commitment to accuracy, fairness and transparency in our editorial guidelines.
- Bishop, J. (2022, January 25). Annuities vs. Mutual Funds: Which One Is Best for Retirement? Retrieved from https://due.com/blog/annuities-vs-mutual-funds-retirement/
- Financial Industry Regulatory Authority. (n.d.). Mutual Funds. Retrieved from https://www.finra.org/investors/insights/mutual-funds
- InvestmentNews. (n.d.). 10 largest mutual fund companies by assets. Retrieved from https://www.investmentnews.com/galleries/10-largest-mutual-fund-companies-by-assets
- Trust Point LLC. (2022, May 11). Annuity vs. Mutual Funds: Which Is Right For You (Pros and Cons). Retrieved from https://www.trustpointinc.com/variable-annuities-vs-taxable-mutual-funds/
- U.S News & World Report. (2010, February 23). About the U.S. News Mutual Fund Score. Retrieved from https://money.usnews.com/money/personal-finance/investing/articles/2010/02/23/about-the-us-news-mutual-fund-score
- U.S. Securities and Exchange Commission. (2005, October 17). Mutual Funds. Retrieved from https://www.sec.gov/investor/tools/mfcc/mutual-fund-help.htm
Calling this number connects you to Senior Market Sales (SMS), a trusted partner of Annuity.org.
If you're interested in buying an annuity, a representative will provide you with a free, no-obligation quote.
SMS is committed to excellent customer service. The company can help you find the right insurance agent for your unique financial objectives.877-918-7024