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Mutual Funds vs Variable Annuities

By April 26, 2022 No Comments

Watch the video below to learn the difference between a mutual fund and a variable annuity and what the true cost are of both!

 

To explain how Tax-Deferred accounts don’t always translate to tax-savings, let’s walk through what the cost differences will be from investing in a mutual fund or a variable annuity.

We’ll assume there is an initial investment of $100,000 into each of these accounts.

 

For the mutual fund, we have to remember that the gains are taxable each year. We’ll use a rate of return of 10%… so without taxes, in 20 years, this fund would be worth $672,000. However, since we’ll have to pay the taxes on this mutual fund growth as we go, the real value to the investor after the 20 years would actually be $575,000.

Person A

Mutual Fund:

Initial Investment = $100,000 (After-Tax)

Assumed ROR: 10%

20% Tax Rate (Paid Annually on Gains)

FV (Future Value) = $672,000

Real Value = $575,000

 

Initially, by seeing almost $100,000 less due to taxes, many Savers might say, “Why wouldn’t we invest in a tax-deferred annuity and walk away with the whole $672,000 instead of $575,000!”

 

Person B

Variable Annuity:

Initial Investment = $100,000 (After-Tax)

Assumed ROR: 10%

3% Annual Fee

After Fees – FV = $365,000

Taxable Gain = $265,000

Differed Taxes on Gain 20% = ($50,000)

Real Value = $215,000

The missing information here, is that tax-deferral does not mean tax-savings. Fees on products like variable annuities can sometimes outweigh the opportunity for earning any interest at all. In this example, with the same assumed ROR and a 3% annual fee, the Saver sees a gain of $265,000, but all of that is now taxable if they were to liquidate this account.

 

One important thing that all Savers should understand is, “If it’s too good to be true, then it probably is.” As Tony says, “There’s no such thing as a free lunch!”

 

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