A closer look at cash, annuities and mutual funds
You have an array of choices for putting money away for future purposes.
There are investments, annuities, bank deposits and much more. Your decision should be driven by your circumstances including:
Cash investments offer low volatility and immediate access. Types of cash investments include:
"Cash investments are liquid, relatively safe and have shorter investment periods."
Cash investments are liquid, relatively safe and have shorter investment periods. Traditional checking and savings accounts at banks and credit unions are the most common. They offer guarantee of principal (FDIC insurance up to a certain amount) but earn low or no interest. Other cash-based types include:
Cash investments provide:
Drawbacks to cash:
An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. While the fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money while investing in the fund. Don't confuse money market funds with bank money market accounts.
"Annuities can provide you with a guaranteed income source to help ease worries of running out of money in retirement."
Annuities can provide you with a guaranteed income source to help ease worries of running out of money in retirement. You can purchase an annuity with an income option that pays income guaranteed to last for the rest of your life. An annuity is a contract between you and an insurance company. During the accumulation phase, you pay money to the insurance company (premiums). In exchange, the insurance company guarantees to make payments back to you at regular intervals. This is called annuitizing, and once selected, it is not reversible. This is the payout phase. You can purchase an annuity with an income option that pays income guaranteed to last for the rest of your life, even after your account value is completely depleted. This is the insurance part. All guarantees are backed by the claims-paying ability of the issuing insurance company. Annuities' unique structure also provides tax-deferred growth. Annuities are long-term investments for future income and should not be used for short-term goals.
The life insurance industry has been able to keep its financial commitments partially because of the strength and dependability of the legal reserve system. Though not an insurance or guaranty fund, the legal reserve system is a strict, regulatory framework to which all life insurance companies must adhere in order to offer products to the public.
Your annuity value is the sum of premiums paid (how much money you save in it), minus charges (typically for early withdrawals), plus the interest that has been credited. This value is used to calculate benefits you will receive.
Note that you will need to pay income taxes when you withdraw your money, and if you withdraw money before you reach age 59½, you may be subject to a 10% early withdrawal penalty. Annuities typically have surrender charges which become effective if you withdraw the money before a set number of years. With variable annuities, the value of your investment will fluctuate with the markets; when you cash in your variable annuity, your investment may be worth more or less than you originally paid.
Annuity income options
There are several different annuity income options to choose from. Fixed annuities and variable annuities offer the opportunity to "annuitize" the money you have saved. Annuitization is an option that can provide lifetime income payments. The "annuitization phase" is the payout option that can provide you with income payments for life, depending on the option you select. You can annuitize all or a portion of your account balance and decide how often you want payments. Once you choose, it's generally irrevocable.
If you annuitize a fixed annuity, you'll receive a predictable stream of fixed, periodic income payments. With a variable annuity, the income payments fluctuate depending on the performance of the underlying investment.
Fixed payout options. The cash value of your account is used to fund a fixed payout. That payout offers a locked-in rate and provides a guaranteed dollar amount. Even if interest rates change, your payments won't change unless the option includes an inflation adjustment feature.
Variable payout options. This option provides scheduled benefit payments and the potential for investment growth that, historically, has outpaced the cost of living. Your payments will fluctuate with the performance of the investment options and the interest rate you have chosen.
Combo fixed and variable payout option. To minimize investment risk and maximize returns, you may wish to combine fixed and variable payout options.
Guaranteed lifetime payout options
This payout method typically offers three options that can turn your annuity into regularly distributed income for as long as you live. All guarantees are backed by the claims-paying ability of the insurance company.
Income for a specific period for fixed and variable annuities
Options may be available that pay income for a fixed period but are not guaranteed for life.
If you aren't ready to receive annuitized distributions but you need to meet certain financial needs, this option allows you to receive partial withdrawals. Meanwhile, the rest of your funds will continue to grow tax deferred. Unless an exception applies, the distribution may be subject to a 10% federal early withdrawal penalty if you are under age 59½.
Single-sum (lump-sum) distribution
You can withdraw all the money from your annuity as a single, lump-sum payout. Unless an exception applies, the distribution may be subject to a 10% federal early withdrawal penalty if you are under age 59½.
As an alternative to annuitization, systematic withdrawals let you receive income automatically at specified intervals. But you still maintain access to your accumulated retirement account balance. You can make systematic withdrawals by:
Note that this method could eventually reduce your annuity balance to zero. Also keep in mind
that unless properly structured, the withdrawals may be subject to a 10% federal tax penalty if you are under age 59½.
Leave the funds on deposit
If you don't need income right away or if you want to preserve capital for your estate, you might be able to leave your funds on deposit. The benefit? Your annuity can continue to grow tax deferred until you withdraw it or to meet required minimum distributions in an eligible retirement plan.
Optional income protection for variable annuities
If you own a variable annuity, you may be able to purchase an optional guaranteed minimum withdrawal benefit (GMWB) to help protect your retirement income against market downturns. A GMWB allows the withdrawal of a maximum percentage each year of an amount that increases with market gains but does not decrease with market downturns.
"Mutual funds pool the assets of many investors to buy a collection (portfolio) of different securities which are overseen by a fund manager or team."
Mutual funds can help you diversify across many stocks and bonds. Mutual funds pool the assets of many investors to buy a collection (portfolio) of different securities which are overseen by a fund manager or team. Managers invest the assets according to a fund's prospectus, which describes its objectives, history, risks, financial statements and manager backgrounds. Mutual funds can diversify individual investments across many stocks or bonds.
Before investing in a mutual fund, you should be familiar with its underlying assets: stocks, bonds and cash equivalents:
Over the past 25 years, mutual funds have attracted trillions of dollars from investors. While mutual funds offer the advantages of diversification and professional management, they also involve risk. Fees and taxes may also diminish a fund's returns. Understand the advantages and risks of investing to choose products that match your goals and risk tolerance.
Fees, expenses and taxes
All mutual funds have fees and expenses which reduce the return on your investment, particularly over the long term. Before investing, read the fund's prospectus to assess its fees and annual operating expenses.
Shareholder fees: Includes commissions paid to brokers when shares are bought or sold. Commissions are funded by sales charges (either front-end or back-end).
Annual operating expenses: The costs of managing and operating a fund including management services, record keeping, printing and mailing.
Taxes: Mutual funds must distribute all income and capital gains to shareholders each year. Therefore, shareholders must pay income taxes on any distributions (dividends or capital gains). Each fund company provides an IRS Form 1099 to shareholders annually, summarizing the fund's distributions. When selling shares, shareholders will have either a taxable gain or a loss. If the mutual fund investment is held in a tax-qualified retirement plan, you can defer those taxes until you withdraw the money, usually in retirement. Penalties may apply if you withdraw the money before age 59½.
Mutual fund investment styles
Mutual funds offer flexibility, diversification and a nearly endless variety. Investment style describes what they invest in.
Main investment styles:
Mutual funds may also have specific investment strategies such as:
Exchange-traded funds (ETFs)
While not technically mutual funds, these securities share some similarities. Like mutual funds, ETFs are a collection of stocks or other securities. A big difference is that ETFs are traded like individual stocks, so their price fluctuates throughout the day. They are also sold through brokerages which charge a commission each time you buy or sell. Mutual funds are only priced once per day, after the market closes, and may or may not charge to buy or sell shares.
*"Standard & Poor's®," "S&P 500®," "Standard & Poor's 500" and "500" are trademarks of The McGraw-Hill Companies, Inc. The S&P 500 Index is an unmanaged stock index. An investment cannot be made directly in an index.
A few key financial factors to consider: