Variable Annuities Vs. Mutual Funds

Individuals who are planning for retirement are on the lookout for investments that not only yield better returns, but are relatively risk-free. The popular options, at present, are mutual funds and annuities and here, we shall try to understand the difference and similarities in both these investment options.
The concepts of variable annuities and mutual funds are quite similar to each other, by the virtue of general mechanism and overall working of the investment and returns. Though the working of the two is quite similar, and the rate of return offered by both types of investments is almost the same, there is a subtle line of difference between these.

How do Variable Annuities Compare to Mutual Funds?

In comparing variable annuities with mutual funds, it is first important to understand the definitions and basic structure of both these types of investments. A mutual fund is said to be an investment vehicle, which is made with the help of a pool of money which is contributed by several members. The pool is sometimes made up of several shares. So basically it's a large contributed sum of money which the fund managers, systematically invest into several sources that range from companies, corporations, stock markets and money markets.

Mutual funds have an option of reinvesting the returns. The mutual fund company shares the profits made from the investments with the owners of the shares or mutual fund investors. The investment contribution is either a one time payment, or is done in a set of several installments. The repayments or returns are however, done with the help of several payments. In case of reinvestment of the funds, a specified lock-in period is prescribed, before which the share or contribution can be withdrawn.

Now this is the most important part, the returns of a mutual fund are subject to market risks and even if the portfolio of investments is managed by professional fund managers, the returns are always in proportion with the portfolio performance, hence basically a mutual fund is completely subject to all market risks.

An annuity, on the other hand, is principally a contract of insurance wherein the annuitant or the owner of the annuity makes certain payments to the company which like in the case above, invest into professionally managed investment destinations. The company repays the annuity owner or contributor the returns on the basis of periodic intervals.

Now in the case of fixed annuities, the returns are fixed and predetermined. However, in case of variable annuities, the individual repayment is made up of Guaranteed Minimum Income Benefits, meaning that this sum is paid to the annuitant irrespective of the portfolio's performance. The second part of the returns is compromised of what is known as a bonus. This bonus depends upon the portfolio performance. Thus in short, the returns are partially subject to market risks.

There are equal number of pros and cons of variable annuities, if you compare them with mutual funds. One big advantage of variable annuities is that they have a great death benefit, meaning that the annuitant's surviving relatives receive a set of returns which are subject to withdrawals from the annuity, if any.

Variable Annuities Vs. Mutual Funds

Here is a table depicting the differences in the two types investments and their features that distinguish them from one another.

Particulars of ComparisonVariable AnnuityMutual Fund
Type of investmentQuasi-insuranceInvestment fund
ReturnsSemi-variableSubject to market risk and variable
Appropriate investor age40 years or above Below 40 years
Term /average time periodMainly long term, reaching about 10 yearsFound in all time periods, short, long and medium
WithdrawalPermitted till a certain percentagePermitted but after a stipulated lock in period
Tax implicationChiefly tax differed, but taxed upon returnsReturns taxes as capital gains
Rate of returnQuite low as compared to mutual fundsHigher than mutual funds
Level of riskLess risky than mutual fundsMore risky than annuity
Guarantee of incomeGuarantee of income till a certain pointNo guaranteed income
Death BenefitAssured death benefitNo death benefit

Though you can take help of the aforementioned table, points of comparison and other factors, calculating the rate of return and then assessing and making a decision, always works out.