“Both an annuity and a bond can assure you of a steady income when you retire. But these two instruments have some important differences. So it’s crucial to know exactly how they differ before you decide which one to include in your portfolio.” Ed Hochard
Both annuities and bonds are popular with pre-retirees and retirees who desire a steady income when they no longer receive paychecks. However, before deciding whether to include bonds, annuities (or both) in your retirement income plan, you should be aware of both products’ essential similarities and differences.
How are bonds and annuities alike?
Because there are so many varieties of bond and annuity products, comparing the two can be a little challenging. However, most bonds and annuities do share some things in common. For example, you use lump sums of cash are usually used to purchase both annuities and bonds. Issuers of both instruments structure payouts for set periods. Both an annuity and a bond have specific payment dates and stated payment rates. Both annuities and bonds are considered helpful additions to a portfolio’s “safe money” allocation.
Differences between bonds and annuities.
While annuities and bonds share some things in common, there are several critical differences between the two products.
- The nature of the relationship between the issuing company and the holder is different. When you have an annuity, you are party to a contract. When you own a bond, you are a lender.
- Annuities can be more negotiable than bonds. Before finalizing an annuity contract, you can add riders, benefits, add beneficiaries, or even modify some provisions.
- A bond indenture, on the other hand, is not negotiable. You cannot modify a bond’s terms. When you own a bond, you agree to loan money to the issuing company on their terms, not yours. In exchange for agreeing to a bond issuer’s terms, you get a fixed rate of interest for the life of that bond.
- An annuity has more significant tax benefits. Generally, only an annuity’s return on investment is taxable. Income from bonds is entirely taxable. The result of an annuity’s tax-preferred status is that they typically create higher after-tax income streams. However, be aware that with more increased cash flow comes less liquidity. Annuities can be complicated to sell, and sellers must often turn to a less-liquid secondary market. Bonds, on the other hand, can be bought and sold on the same day. For many seniors, less liquidity isn’t a factor when they purchase annuities. That’s because they don’t want to lose a penny of their principal investment. The protection of principal an annuity provides is not available with bond products.
- Bonds create income for finite periods only. Annuities, though, are structured to create a lifetime income stream that you can’t outlive.
The Bottom Line
Both annuities and bonds create steady sources of predictable retirement income. When you have an annuity, though, your income can last for the rest of your life, even if you live to age 100. By contrast, bonds provide money for only a specific amount of time, from a few months to 30 years or longer.
There are numerous configurations of bonds and annuities. That’s why it can be daunting to compare their pros and cons. Finding the perfect one for the safe money portion of a portfolio is not a task you should leave to chance. Be sure to partner with a qualified financial advisor who knows both bonds and annuities before purchasing these safe money assets. Your expert will make recommendations based on current interest rates, your risk tolerance, and your time horizon, among other factors.