Neither mutual funds nor annuities are qualified financial products that allow you to deduct your contributions. If you’re looking to reduce your tax obligations by contributing to your retirement funding you will need a qualified fund such as a Traditional IRA. Still, there are major benefits to be had from investing in mutual funds and annuities. As products often bought by the elderly, they have very different values that should be considered before being purchased.
Mutual Fund (MF) Pros
• No limit on withdrawal periods
• No limit on contributions or deductions
• Extensive products to choose from
• Growth is subject to capital gains tax only
• Liquidity is accessible year round
• Beneficiaries may benefit from step-up basis built into the fund
• Growth is Tax Deferred
• Investment converts to non-taxable insurance upon death of owner
• Assets protected from creditors in 75% of U.S.
• Some built-in guarantees protecting the value of the account
• Guaranteed Retirement Income (beneficial if you live an especially long life)
Even with these positive elements making both the mutual fund and the annuity look attractive to many, they have unique characteristics that make them more appropriate for some and inappropriate for others. The investor will also select one of these options if he or she is considering the product for retirement savings or simply general asset growth. Both products generally have fees associated with the purchase and maintenance of the accounts. There may also be penalties and limits to consider before making your final decision.
• Capital gains subject to annual taxation
• Assets seizable if owner is sued
• Is not a qualified investment unless part of a qualified account portfolio – does not grow tax deferred
• No guarantees for the value of the fund
• Annual asset withdrawal is limited
• Limited investment options
• Sales fees and expense ratios can be high
• Assets lack liquidity
• Growth is taxed as income (a higher rate than capital gains)
• Can only access monies without penalty after reaching retirement age
Consider the pros and cons associated with purchasing either of the investment tools. It is advisable to discuss your choices with an unbiased investment advisor. The advisor will select the option which provides for the least amount of penalties, fees, expenses, tax obligations as well as the investment with an appropriate duration of investing and withdrawal periods. It is imperative to not only evaluate the accumulation period, but also the withdrawal period of the investment.
Protecting the Investment Value
If you are a very conservative investor, some annuities may provide enough protection to give you adequate comfort. Some annuities also offer original investment protection. Even if you suffer losses, the annuity guarantees you do not lose the value of your original investment. MFs offer no guarantees or protection of your investment. Naturally, they are more suitable for investors who can tolerate losses.
Limits on Contributions or Withdrawals
Mutual funds have no limits on either contributions or withdrawals. If the mutual fund is a part of a retirement vehicle, the vehicle’s federal guidelines will govern the contributions. Annuities have no limits on the contributions, but there are limits on the withdrawals.
Removing money from an annuity is considered a withdrawal or surrender. Withdrawals from annuities prior to age 59 and 1/2 are subjected to a 10% early withdrawal penalty. After the first year, owners can withdraw up to 10% annually of the contracts previous year’s value without suffering a surrender charge. After age 70 and 1/2 the IRS institutes a required minimum distribution that must be paid out annually to the annuitant. The surrender period is defined by the contract and ranges from three to nine years. Surrender charges during this period are usually a percentage based on the number of years the contract has been in force. The charges decrease as the years elapse.
Taxation of Investment
Funds are taxed according to capital gains rates. Capital gains rates are based on your tax bracket. The lower your tax bracket, the lower your capital gains rate. If your tax bracket is 15% or less, you owed O in capital gains in 2013 and 2014. Tax brackets of 35%-25% owed 15%. Tax brackets of 39.6% owed 20%. These are the tax rates for non-qualified mutual fund earnings.
Annuity taxation is based on income rates which start at 10% for an income of $9,075-18,150 and 15% for an income of $9,075- 73,800. It goes up to 39.6% when you reach income levels above $406,750. Unlike mutual funds that are taxed on gains only, annuities are taxed on the full amount received annually.
The benefits of investing in one vehicle versus the other, is based on your investment goals. Annuities offer more guarantees and no limits on contributions, but are taxed more aggressively and have more limits on withdrawals. MFs have no limits on withdrawals or contributions, but offer no guarantees on investment value. In the end the taxation and purpose for your investment may determine which investment is best for you.