Annuity or Mutual Fund for Retirement?

Dear Dr. Don,I have a large amount of money in a bank account making less than 1% interest. It's not a retirement account. I have been looking at annuities that will not lose principal but keep your money safe and promise income for life, and mutual funds that pay dividends but have market risk. I am 55 years old and would like to retire at 66 at my full retirement age. I do have a 403(b) account, but I would like this money to be invested outside of a retirement account. What is the better choice?-- Marge Mutual

Dear Marge,Depending on the type of annuity you choose, you could have some of the same investment choices in the annuity that you have with the mutual funds. A variable annuity invests your money in subaccounts that you pick from the ones available with the insurance company. There's market risk in variable annuities, but it can be limited by insurance provisions in the annuity contract. In contrast, a fixed annuity pays a stated rate of interest on the annuity balance. Variable annuities have a level mortality and expense, or M&E, fee that a mutual fund doesn't have, but it's those M&E fees that fund the insurance component of the annuity contract.

The monies invested in an annuity contract are tax-deferred, like your 403(b) investments, while investing in a mutual fund in a taxable account has annual income tax implications. That's because a mutual fund is required to distribute out to its shareholders any dividend income and realized capital gains.

Another option is to invest in stocks and bonds in a taxable brokerage account. The advantage to this is that you can, to an extent, manage the tax impact of your investments. You don't realize a capital gain (or loss) until you sell an investment. A possible advantage here is a step-up in basis if the investments were to be inherited at your death. This advantage depends on the estate tax code in effect when you die.

If you're eligible for a pension and Social Security benefits in retirement, I'd hesitate to recommend investing in an annuity contract, because you already have two sources of retirement income that are annuities.

I suggest working with a fee-only financial planner to help you decide where and how to invest the money. The Bankrate feature, "Financial planners: Not just for millionaires anymore," can help you pick one, as can the National Association of Personal Financial Planners publication, "Pursuit of a Financial Advisor Field Guide."