Annuities vs. Bonds: which would be better?
Senator Rob Portman recently revealed that about 10,000 baby boomers hit retirement each day. The typical retirement age is 65. This is the time when most retirees experience confusion. The employment that was a haven for income flow ceases. As such, investment advisors and consultants have recently found themselves answering questions regarding the best financial instruments and schemes to adopt for investment.
One question many ask is — between annuity and bonds, which would be a better source of income for a baby boomer? Before going into details, we must understand the two instruments. Bonds are investments in which the bondholder typically lends money to a corporation for a defined timeframe and interest rate. Annuities are agreements in which the insurer pays the annuitant periodic amounts upon the maturity of the contract until the annuitant dies.
- Annuities have a guaranteed lifelong income flow
Annuities, and especially fixed indexed annuities with income riders, have a guaranteed lifetime inflow of income. They, therefore, offer the baby boomers financial protection. Bonds, on the other hand, are not lifetime sources of income, but, rather, investment strategies. Bond income is not perpetual, and what is worse, their inflows shift with interest rates.
- Do bonds offer the retirees liquidity benefits?
Annuities are long-term contracts, between five to 10 years to be exact. This means that if you need access to more than 10% of the amount deposited in the annuity you will pay a surrender fee. On the other hand, one can sell their bonds at any time, especially when a need for liquid cash arises. There is one thing to consider with bonds; when selling the bond, you have no assurance that you’ll get what you paid for it. If interest rates rise, you typically won’t find anyone who’s willing to give you full price on your old bond with a lower rate. You’ll most likely be forced to sell at a discount. Granted, the inverse is true as well, but you’d have to assume that interest rates would continue to go down. With an annuity you can withdraw up to 10% without any fees or charges, and some allow you to withdraw up to 20%.
- Annuities are protected from market fluctuations
One thing that stresses retirees is the interest rate risk. This risk creates uncertainties on the level of returns to expect from an investment. Unlike annuities, bonds are highly susceptible to increase in interest rates. A rise in interest rates lowers bond prices. This reduces the expected returns. Annuities offer a guaranteed sum of income regardless of the interest rates.
- Annuities tend to be expensive
Most analysts have established that annuities appear to be more expensive than equivalent bonds. Annuities attract more expenses than bonds. Every feature and option an investor adds to an annuity will always call for an extra cost. Moreover, some annuities, such as the fixed annuities, need additional protection such as inflation cover to help shield the regular income during inflation.
- Bonds have higher yields
The investment rule seems to apply here: the higher the risk, the higher the return. Investing in bonds attracts a greater risk, but this translates to higher yields in most occasions in the short-run. To earn more, a greater risk level must be present. Unlike bonds, annuities have lower risks and thus a lower return level in the short-run. Annuities, however, in the long-run could yield higher incomes than equivalent bonds.
The Bottom Line
Deciding which investment tool is the best would lead to bias. Each has its benefits and the tastes and investment plans of baby boomers vary from one to another. Annuities are good for those who wish to have a quiet life after retirement with a secure income. Bonds will be more flexible in that they will offer retirement returns in addition to other options of diversification. Therefore, the choice is really for the baby boomer!
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I honestly had no idea what income annuities were before I read this article. I think that lots of people can benefit from having it though. Some people need the extra income from month to month, but it is always wise to be smart about it!