8-minute article

Indexed annuities and mutual funds: What’s the difference?

Annuities Retirement planning

When discussing retirement planning with clients, you can begin by addressing their questions and concerns. Are they worried about losing principal during a market downturn? Running out of income in retirement? Or missing opportunities for long-term growth?

While indexed annuities and mutual funds are sometimes viewed as an either-or proposition, they are designed to help address different objectives. It’s not about which product is better. It’s about the role each one could play in a strategy to help meet specific retirement goals.

Key takeaways

Mutual funds offer market-based growth with direct market exposure and long-term growth potential.
Indexed annuities offer growth potential tied to the performance of an external market index and provide a level of downside protection.
A fixed indexed annuity’s guaranteed lifetime income options can help provide income stability in retirement.

Key differences between indexed annuities and mutual funds

Indexed annuities	Mutual funds
Finite growth potential in exchange for protection from market losses	Full participation in market gains and losses
Growth potential linked in part to an external market index	Direct participation in underlying investments
Tax-deferred growth	Tax treatment depends on account type and investment activity
Guaranteed lifetime income options	Primary focus on accumulation and investment growth
Subject to withdrawal charge periods and withdrawal limitations	Generally offers daily liquidity

Indexed annuities generally fall into two categories: fixed indexed annuities and registered index-linked annuities. While they’re similar in some respects and both can be used in retirement planning, they’re typically used for different purposes.

Fixed indexed annuities generally can help provide an income option in retirement, and they offer growth potential with protection from market downturns. A registered index-linked annuity offers higher growth potential than a fixed indexed annuity and a level of downside protection from market loss. While some registered index-linked annuities may include an income option, they are generally used for accumulation.

What is a fixed indexed annuity?

A fixed indexed annuity, or FIA, is an insurance product designed for long-term retirement planning to help protect retirees from outliving their money. A FIA offers opportunities for growth while helping protect principal and earnings from loss during market downturns. They’re also commonly used to generate guaranteed income in retirement through income riders or annuitization.

As a type of indexed annuity, FIAs are not directly invested in the markets. Instead, they are linked to the performance of an external market index, such as the S&P 500^®.

What is a mutual fund?

A mutual fund is an investment vehicle that pools money from multiple investors to purchase a diversified portfolio of securities — stocks, bonds and other investments. Professional portfolio managers oversee the fund and make investment decisions according to the fund’s objectives.

Mutual funds are often used to pursue long-term growth, generate income or provide diversification across asset classes and sectors. Because they invest directly in financial markets, their value rises and falls with the performance of their underlying holdings.

One of the primary advantages of mutual funds is liquidity. Investors can generally buy or sell shares on any business day. However, that flexibility comes with full market exposure. When markets rise, investors participate in the gains. When markets decline, investment values also decline.

In other words, mutual funds have no built-in “floor” protecting against losses, but they also have no “ceiling” limiting gains.

How mutual funds and FIAs generate growth

Although both products can fit within a retirement strategy, they generate growth differently.

Mutual funds participate directly in the performance of the securities they own. A stock mutual fund, for example, rises and falls based on the value of the stocks held within the fund.

FIAs earn interest credits based in part on the positive movement of their underlying market index or indices. Once interest credits are earned, they’re locked in and cannot be lost to future index declines. Because of this structure, FIAs can provide growth potential without exposure to direct market losses.

The “floor and ceiling” framework can help explain a FIA

Fixed indexed annuities have a “floor,” or zero floor, which represents protection from market losses. If index performance falls below 0%, no interest credits are earned during that specific crediting period. Negative performance of an underlying index doesn’t impact the annuity’s value. Since owners can’t earn less than 0% due to index performance, their principal and previously credited interest are protected from market downturns.

The “ceiling” represents the tradeoff for that protection. Interest-crediting methods such as participation rates, caps or spreads may limit how much of the underlying index’s positive performance is credited during a given crediting period.

This structure can appeal to clients who want growth potential but are uncomfortable exposing a portion of their retirement assets to full market volatility.

Can fixed indexed annuities lose money?

Unlike mutual funds, FIAs aren’t direct investments in financial markets. Therefore, they can’t lose money due to market downturns. A FIA’s zero floor protects principal and interest earnings from index losses.

Most fixed indexed annuities include a surrender charge period, meaning withdrawals above certain limits during this timeframe could incur charges that may result in a loss of principal. The annuity could also have other annual fees and charges that are deducted even if the interest credit is 0%.

The tradeoff is straightforward: Mutual funds offer uncapped market participation, while FIAs exchange some upside potential for protection from market downturns.

How market risk differs between mutual funds and FIAs

Market risk is one of the most important distinctions between the two products.

While full market exposure with mutual funds may help support long-term growth, it can also result in exposure to loss in volatile markets.

What are the risks of mutual funds in retirement?

For retirees and pre-retirees, volatility can create sequence-of-returns risk — the possibility that poor investment performance early in retirement, combined with withdrawals, can accelerate portfolio depletion.

Are fixed indexed annuities “safer” than mutual funds?

A FIA can help address sequence-of-returns risk by providing protection from market losses while still offering growth potential. Some clients use FIAs as part of a broader strategy designed to create income stability during retirement while allowing other assets to remain invested for the long term.

In contrast, mutual funds are exposed to full market loss but participate in full market gains. For financial professionals, the conversation often comes down to helping clients understand which tradeoffs align with their goals, risk tolerance and retirement timeline.

Liquidity and access to funds

Access to funds is another important consideration when evaluating mutual funds and FIAs.

Mutual funds generally offer daily liquidity, allowing clients to access money when needed. This flexibility can be important for anyone who may need money on short notice.

Fixed indexed annuities are intended for longer-term retirement assets, although they often allow limited annual withdrawals without charge. Most FIAs include withdrawal charge periods in which a charge is assessed if withdrawals exceed certain limits.

For this reason, financial professionals often encourage clients to match products to time horizons. Greater access to funds may be better for money that’s needed in the near term. Money intended to meet long-term retirement goals may be appropriate for solutions such as a FIA that prioritize protected principal, growth potential and income.

Tax differences between mutual funds and FIAs

Tax treatment can also influence how these products fit within a retirement strategy.

Annuities grow tax-deferred, so clients don’t pay taxes on earnings until they withdraw money. These withdrawals are generally taxed as ordinary income.

On the other hand, long-term mutual fund gains are taxed as capital gains, and the rates may be lower than ordinary income tax rates. Depending on a client’s tax bracket, this distinction can affect the net outcome.

Incorporating mutual funds and fixed indexed annuities into a retirement strategy can help create tax diversification later in life. Depending on income needs, tax brackets and other factors, having multiple sources of retirement assets may provide more flexibility.

Clients should consult with a qualified tax professional regarding their individual circumstances.

Which option fits different retirement goals?

For many financial professionals, the most productive conversation is not whether a client should own a mutual fund or an indexed annuity. It’s determining which risks each one helps address. They aren’t competitors. They are different solutions that can serve different purposes within the same retirement strategy.

A portfolio-role approach

This approach considers the role each product can play within a client’s portfolio.

A mutual fund could be used to:

Pursue long-term growth
Help maintain purchasing power over a retirement that could last 30 years or longer
Provide easier access to money needed in the short term

A FIA may be used to help:

Protect a portion of retirement assets from market losses
Address volatility concerns
Support income planning

A RILA could be used to help:

Pursue growth opportunities
Protect a portion of assets with a level of protection from market loss
Buffer loss if the underlying market index declines

Rather than asking which product is better, a more useful approach may be to shift the focus to individual goals and concerns. Once those are established, it can be easier for clients to understand which product, or what combination of products, may be appropriate for their needs.

The bucket approach

A segmented “bucket” strategy is another practical framework for helping clients find the right portfolio mix.

Bucket	Purpose	Potential allocation
Bucket 1: Near-term income	Assets needed within the next several years	Cash or short-term investments with easy access
Bucket 2: Protected principal	Assets that aren’t needed immediately but that clients want protected from significant market declines	A fixed indexed annuity
Bucket 3: Long-term growth potential	Assets with the longest time horizon	Growth-oriented strategies such as mutual funds, or a RILA where the benefit of time may help minimize the impact of market volatility

The bucket framework can help clients visualize the ways different assets can serve different purposes within a retirement strategy.

Balancing income and growth objectives

Retirees often have multiple goals at the same time.

They may want predictable income to help cover essential expenses and long-term growth potential for discretionary spending, legacy planning or to help offset the effects of inflation. In these situations, a FIA can help support a client’s desire for income certainty, while mutual funds may help meet their goal for long-term growth.

This diversified approach can help address multiple retirement risks at the same time instead of relying on a single solution.

Understanding tradeoffs

Every financial product involves tradeoffs. The core tradeoff between indexed annuities and mutual funds is protection versus flexibility. A FIA trades liquidity and greater upside potential for protection from market downturns and tax deferral. This tradeoff can be useful for clients with conservative accumulation goals or retirement income-planning needs.

The tradeoff with a RILA is higher growth potential in exchange for accepting some level of risk. However, RILAs can offer a level of downside protection that helps limit market losses.

Mutual funds offer transparency, liquidity and uncapped growth. In exchange, the investor absorbs every bit of market volatility.

Helping clients understand the tradeoffs before they decide can help them have clearer expectations and greater confidence in their retirement strategy.

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Key takeaways for retirement planning

When talking with clients about FIAs and mutual funds, leading with their retirement goals or specific concerns instead of the product can help lead to more productive outcomes.

Questions like these can help you identify the risks clients are most interested in addressing:

What retirement expenses are non-negotiable?
What is your biggest financial concern — losing principal, outliving assets or missing growth opportunities?
How much money could stay invested for the long term?

After identifying their concerns, you can explain how indexed annuities and mutual funds could work together to help address different retirement challenges.

For example, mutual funds can provide long-term growth potential and access to money. FIAs can help provide protected principal and reliable retirement income.

For many retirees, the decision is rarely “which one?” More often, the real question is “how much of each, and why?” Understanding client goals, risk tolerance, income needs and time horizon can help make matching financial solutions to the specific need they’ll meet feel more intuitive. A well-constructed retirement strategy often has a role for both solutions.

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Guarantees provided by annuities are subject to the financial strength and claims-paying ability of the issuing insurance company.

Indexed annuities are not stock market investments and do not directly participate in any stock or equity investments. Market indices may not include dividends paid on the underlying stocks and therefore may not reflect the total return of the underlying stocks; neither an index nor any market-indexed annuity is comparable to a direct investment in the equity markets.

Although fixed indexed annuities offer principal protection from market downturns, the deduction of applicable charges could exceed any interest credited, resulting in the loss of principal.

Withdrawals and surrender of taxable amounts are subject to ordinary income tax and, except under certain circumstances, will be subject to an IRS penalty if taken prior to age 59½.

Any information regarding taxation contained herein is based on our understanding of current tax law, which is subject to change and differing interpretations. This information should not be relied on as tax, legal or financial advice and cannot be used by any taxpayer for the purposes of avoiding penalties under the Internal Revenue Code. We recommend that taxpayers consult with their professional tax and legal advisors for applicability to their personal circumstances.

Under current tax law, the Internal Revenue Code already provides tax deferral to qualified money, so there is no additional tax benefit obtained by funding a qualified contract, such as an IRA, with an annuity; consider the other benefits provided by an annuity, such as lifetime income and a Death Benefit.

The information presented concerning other financial products is not intended to be a comprehensive evaluation or comparison of different products. It is intended to provide comparative information on specific aspects of financial products. Customers should examine all aspects of financial products.

The S&P 500^® Index (the “Index”) is a product of S&P Dow Jones Indices LLC or its affiliates (“SPDJI”) and has been licensed for use by Athene Annuity and Life Company and Athene Annuity & Life Assurance Company of New York (collectively, “Athene”). S&P^®, S&P 500^®, SPX^®, US 500^®, The 500^®, iBoxx^®, iTraxx^® and CDX^® are trademarks of S&P Global, Inc. or its affiliates (“S&P”); Dow Jones^® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”). Athene’s products are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P or their respective affiliates, and none of such parties make any representation regarding the advisability of investing in such product(s), nor do they have any liability for any errors, omissions or interruptions of the Index.