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Annuities vs Stocks

Annuities and stocks are in many ways entirely different animals. Thankfully, they co-operate, and when used together they make an excellent retirement plan.

One cannot honestly compare annuities and stocks because they are simply far too different, and serve two entirely different purposes. Stocks are ownership in a company, purchased as a means to generate capital gains and minor income disbursements in the form of dividends. Annuities are the polar opposite, fixed income investments which do not allow for capital gains (except variable annuities) and are geared toward providing an income.

One major difference between an annuity and a stock is the tax schedule. Annuities are taxed just like regular income. So, if you were to purchase a $40,000 annuity that pays out a total of $50,000 in monthly payments, you would owe full income taxes on the $10,000 “profit.” The personal income tax rates go as high as 35% depending on your tax bracket. A $40,000 purchase of stock that rises to $50,000 would create the same taxed income–$10,000–but would not create the same tax burden. The long term capital gains tax is just 15%.

However, annuity taxation should not be the entire basis of your investment decisions, though they should play a part. You should also consider the amount of risk you’re willing to accept with your investment portfolio.

Fixed annuities will provide a guaranteed, absolute yearly return as well as consistent monthly income checks. Annuities are even backed against failure by your own state government!

Stocks will provide an income if they pay dividends (usually a fraction of what you would earn with the same investment in an annuity) but they rise and fall on a daily basis, and do not have nearly the same protection as an annuity.

One final difference are the returns you’d expect to receive from an annuity and a stock portfolio. The US stock markets have historically gained a healthy 10.5% per year whereas annuities perform just over the current triple-AAA rated bond yields. So the difference between the two in returns can be very, very important to overall portfolio performance.

$10,000 invested in a stock portfolio that returns 10% per year would grow to more than $67,000 in 20 years. $10,000 invested in an annuity with a performance of say, 6% per year would come out to $32,000.

As you can see, a 4% difference in yields creates a scenario in which stocks rise more than twice as fast as annuities.

The Bottomline:

If you have plenty of time before retiring (more than 15 years) you’d be smart to invest in stocks, as they’ll allow for quicker, albeit riskier, growth. If you’re nearing retirement and need consistency more than you need returns, then annuities are the way to go.

The bottomline is that too much one or the other will hurt you just as much as too little of each. So be sure to never overweight fixed income investments (annuities or bonds) when you’ve got time to take risks and never overweight stocks when you’re running out of time. If you follow that simple rule, you’ll never mess it up!