Indexed annuities are retirement investment vehicles designed and maintained by life insurance companies. Bond funds are large pools of investor money managed by teams of professional traders and analysts. Annuities and bond funds may both be suitable in a number of situations, and each of these products carries with it a wide range of potential pros and cons.
A bond fund is a specific type of mutual fund with a portfolio composed primarily of bonds and other debt instruments. Securities like treasury bonds and corporate bonds are common in these types of mutual funds. The actual composition of indexed annuities is unclear because the manner in which interest is credited to the account is the focus, rather than the actual make-up of the investments. Insurance companies leverage customer deposits in order to generate sufficient cash flow to back up earnings in indexed annuities.
The function of bond funds is typically to generate steady income. The principal of your account should remain relatively stable while the securities in the fund generate income from the bond payments. Bond funds are usually purchased when your goal is current cash flow. Indexed annuities are typically purchased at a younger age and used to accumulate wealth for use during retirement.
Bond funds are conservative investment choices, but the risk of losing principal still exists. These mutual funds cannot guarantee the safety of your deposits, nor the continuation of any recurring interest or coupon payments from securities held within the portfolio. Bond funds are vulnerable to market volatility and economic influences beyond anyone's control. Money held within indexed annuities is not subject to the same risks or influences. Even though the annuity's value is tied to a stock market index, your money is not actually invested in the market and therefore not at risk. Indexed annuities are technically categorized as a type of fixed annuity, meaning your account balance is protected and guaranteed by the insurance company. The only potential risk to indexed annuity owners would be the failure or insolvency of the insurance company to maintain its product.
Bond fund shares are easy to liquidate if you decide it's no longer in your best interest to own that particular investment. Cash will be available to withdraw or reinvest in a matter of days after you instruct your broker, adviser or the mutual fund company to cash out your position in a bond fund. Indexed annuities are exactly the opposite and often present a significant challenge if you decide to close your account. Most annuities must be held for several years before your account can be closed without incurring stiff penalties called surrender charges.
Gregory Gambone is senior vice president of a small New Jersey insurance brokerage. His expertise is insurance and employee benefits. He has been writing since 1997. Gambone released his first book, "Financial Planning Basics," in 2007 and continues to work on his next industry publication. He earned a Bachelor of Science in psychology from Fairleigh Dickinson University.