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Real World Scenarios: Variable Annuities Vs. Mutual Funds


The next entry in our series of Real World Scenarios:

What are the primary differences between mutual funds and variable annuities?

Annuities and mutual funds can each play an important part in a financial plan. However, they are different products, designed to meet different needs and time horizons. Both offer professional money management and pooled investment vehicles. Mutual funds may be appropriate for intermediate- and long-term goals. There are many types of mutual funds, ranging from conservative to aggressive risk levels.

Variable deferred annuities are long-term vehicles, designed to help your assets grow and provide a steady stream of income in retirement. Variable annuities offer the following features that are not provided by mutual funds:

  • An annuity provides tax-deferral of any growth. No taxes are due until you take a withdrawal. Depending on the mutual fund chosen, an investor may be responsible for paying annual capital gains tax and dividends. Unlike a mutual fund, however, any taxable withdrawals from an annuity before age 59½ are generally subject to a federal tax penalty of 10%. Ordinary income taxes also apply to earnings.
  • Choice of investment portfolios. These stock and bond investment options may be managed by the same portfolio manager and have the same investment objective as a similarly named mutual fund. However, they invest in separate and distinct portfolios from any publicly available mutual fund and the underlying portfolios have different holdings and fees, so their performance can vary.
  • Tax-free transfers among the investment choices. No taxes are due when you transfer money from one funding choice to another within an annuity.
  • Guaranteed Income for Life. You can convert your investment into a steady income stream that cannot be outlived.
  • Guaranteed Death Benefits. A variable annuity can provide a death benefit that guarantees your beneficiary will receive at least what you contributed to the account, less withdrawals and fees, if you should die before the income payments begin. The death benefit can increase over time.
  • A variable deferred annuity usually has higher annual expenses than a mutual fund. In addition to portfolio management fees, annuities generally have a separate mortality and expense risk and administrative fee.

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