Annuities versus investments

Information courtesy of USAA Life Insurance Company and USAA Life Insurance Company of New York

People like to compare things. It's easy to measure something relative to something else. But it isn't so easy to compare financial solutions or products. Still, questions about annuities compared to other financial products are common. We'll try our best to shed some light on the matter.

Ground rules

Before we dive into the comparisons, let's set some expectations.

• We'll try to keep things general. We can't cover every type of annuity in this article. For a more in-depth discussion of various annuities, their features and benefits, check out Annuities 101.
• When we use the word "annuities" here, we'll keep it simple and discuss deferred fixed annuities, or DFAs. These are also known as Multi-Year Guaranteed Annuities, or MYGAs.
• We'll treat mutual funds and exchange-traded funds (ETFs) as the same thing even though there are many differences between them. This will make it simpler to make general comparisons to annuities.
• Annuities are insurance solutions, not investments.

Annuities versus mutual funds or ETFs

The most popular way for the average person to invest in the stock and bond market is probably through mutual funds and EFTs.^{See note1} A mutual fund or ETF is an investment company that groups funds gathered from investors and makes investments to achieve various financial goals. Mutual funds and ETFs are convenient because they can offer diversification (don't put all your eggs in one basket), professional management (someone else makes the buy, sell, hold decisions) and they're usually liquid (you can easily move your money in and out).

Similarities

We'll compare DFAs specifically to bond mutual funds and ETFs. Here are a few examples of similarities between the two:

• Goal. They both generally seek conservative growth over time.
• Fees or surrender charges.^{See note1} Mutual funds and ETFs can have a range of fees depending on the investment company and type of fund. Annuities also carry fees and surrender charges, but they can lessen over the length of the contract.

Differences

In general, there are several key differences between annuities and mutual funds and ETFs:

• Minimum investment. Annuities generally require a higher minimum investment amount than mutual funds and ETFs. You can usually add to mutual funds, ETFs, and deferred fixed annuities over time.
• Liquidity. It's generally easy to move money in and out of mutual funds and ETFs, but there can be fees. Annuities are long-term commitments. You can typically withdraw a small amount of money without a fee, but you'll have to wait longer to withdraw larger amounts.
• Taxes. Comparing the taxation of mutual funds to ETFs^{See note1} can be complicated, so it's important to understand how taxes can affect you. Taxation of annuities^{See note1} can differ from mutual funds and ETFs as well, depending on the type of annuity, and how they're owned.
• Guarantees.^{See note2} This is a key difference. Most mutual funds and ETFs are not guaranteed. Their value can change depending on market conditions. Annuities are guaranteed. The insurer will return your principal plus a set interest.

Pros and cons

Many people diversify their investments by having annuities and mutual funds and ETFs in their portfolios. There are pros and cons to both, so it's important to choose what works best for your financial goals. So, people might:

• Use bond mutual funds and ETFs as a more liquid part of their portfolio. It's higher risk but has the possibility of higher growth.
• Use an annuity as a secure part of their portfolio. This offers less potential for growth but is also much lower risk.

Annuities versus employer retirement plans

There are numerous types of employer-provided retirement plans like a 401(k), 403(b), TSP, SEP IRA or SIMPLE IRA.

Similarities

Deferred fixed annuities and employer-provided retirement plans.^{See note1} Both are alike in several ways:

• Retirement goal. Both help accumulate wealth over time, usually with the goal of retirement in mind.
• Tax deferral.^{See note3} Annuities and employer retirement plans get two kinds of tax advantages. Traditional^{See note1} accounts are taxed when you receive the payout. There are no taxes on the amount contributed or on the money in the account while it's growing. Roth^{See note1} accounts are different. You must pay taxes on contributions to a Roth. But withdrawals from a Roth are tax free if they meet certain criteria.

Differences

There are quite a few important differences between annuities and employer retirement plans. People can have separate annuities and retirement accounts, or they can have annuities as part of their retirement account. Here are some important points to consider when comparing annuities to retirement plans:

• Contribution limits. Retirement plans have limits on how much money you can contribute each year, set by the IRS.^{See note1} Annuities can allow unlimited contributions.
• How your money is invested. Retirement plans usually offer a selection of different mutual funds depending on your risk tolerance and goals. Annuities are insurance products, and the rate of return can depend on the individual issuer.
• Withdrawals. Retirement plan documents and other regulations control when you can withdraw from a retirement account. Withdrawals from annuities are set by the contract.
• Retirement plan taxation.^{See note1} Taxation will usually depend on whether the plan account is owned as a traditional or a Roth. Traditional retirement plan withdrawals are taxed as personal income. Roth plan withdrawals are tax free. Annuities in a traditional or Roth account are taxed the same way. Annuities held outside a retirement plan (or nonqualified account) are taxed as personal income on the earnings portion when withdrawn.
• Loans. Retirement plans may allow for personal loans depending on the retirement plan document. Annuities generally don't allow for loans but might allow for an annual taxable withdrawal.
• Rules for required minimum distributions, or RMDs. They've changed over the years and, once again, with the newer Secure 2.0 Act of 2022. For many years, the RMD age was 70 1/2 for those reaching age 70 1/2 before 2019. Then the Secure Act of 2019 changed the RMD age to 72 for those reaching 70 1/2 in 2020 or later. Now, under Secure 2.0, the RMD age is 73 for those attaining age 72 after Dec. 31, 2022, and attaining age 73 before Jan. 1, 2033. For those reaching age 74 in 2033 or later, the RMD age will become 75. Annuities held in traditional or Roth retirement plans are subject to the same rules. Annuities held outside of a retirement plan aren't.

Pros and cons

When deciding whether to buy annuities or have a retirement account (or both), it's important to consider the pros and cons of each:

• Some employers will match your contribution to a retirement plan. That is essentially free money for participating in a retirement plan. It's a good idea to contribute at least as much as your employer will match.
• A retirement plan has more potential for growth but comes with some level of risk. If your goal is to grow your retirement savings for retirement, an employer retirement plan can be a good choice.
• Annuities offer less growth but are guaranteed. They may offer less risk to your retirement savings.
• As you approach retirement, an annuity can serve as a low-risk part of your retirement savings. It can be used to generate a stable income stream based on your needs and goals.

Final thoughts

There's a lot to consider when it comes to annuities, mutual funds and ETFs, and employer retirement plans. When deciding how to save and invest for your future, it's important to:

• Keep your goals and needs in mind when considering a financial product or solution.
• Do some homework to better understand the product or solution before diving in.
• Get help when needed to see how the product or solution fits within your financial strategy.

To learn more about annuities, see FINRA.^{See note1} Or visit USAA Annuity Solutions.