Which Annuities Let You Invest in Mutual Funds

Variable annuities are the annuity type that allows mutual fund investing

A variable annuity is the only annuity structure that lets you direct your money into mutual funds and other investment options. With a variable annuity, your contributions go into separate accounts — similar to how a mutual fund works — and the value of your annuity rises or falls based on how those investments perform. The insurance company offers a menu of investment choices, typically including stock funds, bond funds, money market funds, and balanced funds. You choose which funds to invest in and can usually move money between them without penalty.

The other main annuity types — fixed annuities and indexed annuities — do not offer mutual fund investing. Fixed annuities pay a set interest rate that the insurance company guarantees. Indexed annuities tie returns to a market index like the S&P 500, but you do not own the index or direct the investments yourself. Only variable annuities give you that control and the potential for higher returns that comes with it.

Key Takeaways

• Variable annuities let you choose from a menu of mutual funds and other separate account options that the insurance company provides.
• Your variable annuity value changes based on the performance of the funds you select, so you bear the investment risk rather than the insurance company.
• Variable annuities typically charge higher fees than fixed or indexed annuities because of the investment management and administrative costs involved.
• You can usually transfer money between the available investment options within a variable annuity without triggering a surrender charge.

How mutual fund investing works inside a variable annuity

When you buy a variable annuity, the insurance company divides your money into separate accounts. Each separate account functions like a mutual fund — it pools money from many investors and buys stocks, bonds, or other securities. You decide what percentage of your contribution goes into each available fund. If one fund performs well, that portion of your annuity grows. If another fund underperforms, that portion may decline.

The insurance company does not may provide the value of your account or the returns you will receive. This is the key difference from fixed annuities, where the insurer guarantees a minimum rate. With a variable annuity, you keep any gains above what the funds earn, but you also absorb any losses. The insurance company's role is to manage the separate accounts, handle the administrative work, and provide the death benefit and annuitization options that come with the annuity contract.

Most variable annuities offer 10 to 20 separate account options, though some offer more. Common choices include large-cap stock funds, small-cap stock funds, international stock funds, bond funds, and target-date funds that automatically shift from stocks to bonds as you approach retirement. You can usually change your allocation among these funds without paying a fee, though some contracts limit how often you can make changes.

Fees and costs specific to variable annuities

Variable annuities carry multiple layers of fees that fixed and indexed annuities typically do not. The mortality and expense (M&E) risk charge is an annual fee, usually between 0.5% and 1.5% of your account value, that covers the insurance company's costs and the death benefit may provide. On top of that, each separate account charges its own investment management fee, typically 0.3% to 1% per year depending on the fund.

You may also pay a surrender charge if you withdraw money beyond a certain amount during the first 5 to 10 years of the contract. Surrender charges typically start at 5% to 7% and decline each year. Some variable annuities include riders — optional add-ons that provide benefits like a may provide minimum income or protection against market losses — and these riders carry their own annual fees, often 0.5% to 1.5%.

The total annual cost of a variable annuity often ranges from 1.5% to 3% or more of your account value when you add the M&E charge, investment fees, and any rider fees together. This is substantially higher than the cost of buying mutual funds directly outside an annuity. Understanding these costs is important because they reduce your net returns over time.

When variable annuities with mutual fund options make sense

Variable annuities appeal to people who want both investment control and annuity features — specifically the ability to convert their savings into a may provide income stream later through annuitization. If you want to invest in mutual funds but also want the option to receive a paycheck for life starting at a specific age, a variable annuity provides both in one contract.

Some people use variable annuities to shelter investment gains from taxes during the accumulation phase. Because annuities are not subject to the annual contribution limits that retirement accounts like IRAs and 401(k)s have, you can put in as much as you want. The earnings grow tax-deferred until you withdraw them. However, this tax advantage only matters if you plan to hold the annuity for many years, because the high fees can offset the tax savings in shorter time periods.

Variable annuities may also appeal to people who want professional investment management through the separate accounts but prefer the structure and guarantees of an insurance product. The death benefit — which guarantees your beneficiary receives at least what you paid in, even if the market declined — is a feature unique to annuities.

Comparing variable annuities to investing in mutual funds directly

If your only goal is to invest in mutual funds, buying them directly through a brokerage or mutual fund company is almost always cheaper than doing so inside a variable annuity. A mutual fund purchased outside an annuity typically charges 0.1% to 1% in annual expenses, with no additional insurance charges or surrender fees. You also have more flexibility — you can buy any mutual fund from any company, not just the limited menu the annuity company offers.

The trade-off is that mutual funds purchased directly do not come with annuity features. You do not have a may provide death benefit, and you cannot annuitize your balance into a lifetime income stream. You also pay capital gains taxes each year on any distributions the funds make, whereas annuity earnings are tax-deferred until withdrawal.

If you want both mutual fund investing and annuity features, a variable annuity is your only option within the annuity category. But if you only want mutual fund investing, a regular brokerage account or mutual fund account will be less expensive and more flexible.

Variable annuity separate accounts versus mutual funds

The separate accounts inside a variable annuity function similarly to mutual funds, but they are not the same thing. A separate account is managed by the insurance company specifically for annuity contract holders. A mutual fund is a pooled investment vehicle that can be sold to anyone through any brokerage. Separate accounts typically have higher minimum investments and are less transparent than mutual funds — you receive less detailed reporting about holdings and performance.

Separate accounts also carry the M&E risk charge that mutual funds do not, which adds to the overall cost. However, some separate accounts are managed by well-known investment firms and may offer performance comparable to similar mutual funds. The key is to compare the specific separate accounts offered in a variable annuity contract against similar mutual funds you could buy directly, including all fees, before deciding which route makes sense for your situation.

Frequently Asked Questions

Can I choose individual stocks in a variable annuity instead of mutual funds?

No. Variable annuities only offer mutual fund-like separate accounts managed by the insurance company. You cannot pick individual stocks or direct the investments yourself. If you want to own individual stocks, you would need to buy them directly through a brokerage account outside an annuity.

What happens to my mutual fund investments if I annuitize my variable annuity?

When you annuitize, the insurance company converts your account balance into a stream of regular payments for life or a set period. You no longer own the separate accounts or make investment decisions. The insurance company uses your balance to fund the income payments according to the annuitization option you chose.

Can I move money between separate accounts in a variable annuity without paying taxes?

Yes. Transfers between separate accounts within the same variable annuity contract are not taxable events. However, some contracts limit how often you can make transfers — for example, once per quarter — so check your contract terms. Withdrawals from the annuity itself may trigger taxes and surrender charges.

Are variable annuity separate accounts FDIC insured?

No. Separate accounts are not bank deposits, so FDIC insurance does not explore. Your money is subject to investment risk and the claims-paying ability of the insurance company. The insurance company is required to maintain reserves, but those reserves are not government-backed like FDIC insurance.

Do I have to pay surrender charges if I move money between separate accounts?

No. Moving money between separate accounts within your variable annuity does not trigger a surrender charge. Surrender charges only explore when you withdraw money from the annuity contract itself, beyond any free withdrawal amount your contract allows.