Annuity vs Bond Ladder. Bonds and CD ladders are gaining popularity since they are once again yielding profits. We were interested in learning more about the specific distinctions between annuities and bond ladders.
John Scherer CFP(R) and Bridget Sullivan Mermel CFP(R) CPA discuss our definition of bond ladders and CD ladders, which are defined as safe, guaranteed, and consistent income streams provided by the US government. The cash flow will become apparent over time.
Next, we discuss purchasing an annuity, which involves paying an insurance company a predetermined amount of money in exchange for a guaranteed payout that is typically made for the remainder of your life. Thats an immediate annuity. This produces cash flow for your lifetime.
With an annuity—you must realize–I don’t have my money anymore. There is less flexibility. On the positive side, you can’t outlive your money. Generally, your heirs don’t get anything from the annuity.
If you want to have income for the rest of your life with a bond ladder or CD ladder, you have to keep adding rungs if you live longer. However, your heirs get the money that is left.
What are the annuity fees is a crucial question to ask about annuities because they are typically difficult to understand.
One drawback of annuities is that they often lack transparency. It is possible for clients to understand that annuities don’t come with any fees. This is false.
Annuities can be appealing if you want to die penniless or are worried about your longevity. An appealing option if you wish to leave money for your heirs are CD and bond ladders.
For our video describing bond ladders check this out: https://youtu.be/9TjD_b7OVvk
Here’s a video we made about annuities’ red flags: https://youtu be/48cwIOGSIoE.
Bridget: People are interested in bond ladders and CD ladders now that CDs and bonds are profitable again, and we have an episode about that. However, we were interested in learning more about the specific distinctions between bond ladders, annuities, and bond funds. Thus, we’ll cover everything in today’s Friends Talk Financial Planning episode so you can decide what’s best for your circumstances. Welcome to my fee-only financial planning practice in Chicago, Illinois. My name is Bridget Sullivan Mermel.
John: And Im John Scherer. I run a fee-only financial planning practice in Middleton, Wisconsin. Prior to discussing annuities, bond ladders, and CD ladders, I would like to remind everyone to hit the subscribe button. Your subscription makes this excellent content easier for others to find. And with that, bond ladders.
Bridget: Let’s begin by defining a bond ladder and discussing how they are typically built. Therefore, we prefer bond ladders that are safe, meaning the US government has guaranteed them. Therefore, to have that, we typically purchase US Treasury strips. And thats just a specific instrument. And we discuss it in detail in our other video as well. Therefore, we build bond ladders such that each strip matures, or pays out, on a consistent date each year, providing you with guaranteed income each year.
John: To put it another way, purchasing CDs is comparable but not quite the same. For example, if you wanted $50,000 to appear in your checking account the following spring, you could purchase a one-year CD and you would know exactly when that would happen. And if you needed an additional $50,000 in two years, you could purchase a two-year or three-year CD, and you would know that the money would either mature or appear in your checking account during those years. So thats how I explain it to folks.
Bridget: Thats great. So thats the bond or the CD ladder. Now lets talk about annuities. Alright, I’m assuming you are aware of annuities because you used to sell them.
John: Just because someone sells something doesn’t mean they understand how it operates. You could be an excellent salesman but not a very good analyst.
John: Our goal with the bond or CD ladders is to have a dependable, guaranteed source of income. We are certain that the money you have in CDs, which are FDIC insured, or Treasury bonds, which are backed by the government, will materialize over time. We can build it out. Thus, there are five levels, or ten years, on what we refer to as the ladder. With bond ladders, you take a lump sum of money—you have this much to invest—and use it to purchase bonds or CDs to climb the ladder.
But with an annuity, you take that lump sum of cash and, in its purest form, hand it over to the insurance provider, saying, “Listen, here’s my money.” And in return, you typically receive a payout that is assured to last the remainder of your life. Once more, there are various ways to put it together, but to put it simply, I take this money, and I no longer have that money, but what I do have is a promise that I will continue to receive cash flow for the remainder of my life.
John: An instant annuity can be either variable or fixed. And when we discuss it in relation to the bond ladder, it’s about how we’re going to generate cash flow. There are various annuity types that are used to accumulate wealth, but we’re talking about the one that we’re using to generate cash flow. We see this coming in retirement primarily, where utilizing a bond ladder and an annuity in retirement
The trade-off is that, usually speaking, the annuity gives you no flexibility. There are a few different approaches you can take, but they are usually rather costly. But I dont have my money anymore. What would happen if I found out I had some sort of bizarre cancer and decided I would rather have more money in the next three years rather than worry about it thirty years later?
You could receive $1,000 per month, or your payout, with an annuity for the rest of your life, but you’re kind of stuck with that. There’s not as much flexibility as there is with the bond ladder, where you can make different choices. Conversely, if you live to 108, that annuity will continue to pay out for as long as you live, but, generally speaking, the bond ladder doesn’t extend that far.
John: So its sort of this trade off. People often ask which is correct, but like many things in our world, it’s more important to weigh the advantages and disadvantages. With an annuity, you can never outlive the money. That can be a pretty good deal. But you also dont have any flexibility. That could be a pretty bad situation.
Bridget: And for your heirs, its the same situation. If you own a bond ladder, your heirs will inherit the money upon your death. Additionally, if you use treasury bonds, they can be easily sold, giving your heirs a sizable portion of your portfolio. With an annuity, thats it.
Bridget: We’ve discussed how costly annuities can be, but the problem is that they never disclose the fees. Wait, its 2. 25% of what number?.
Bridget: You’re supposed to figure it out, but you still can’t figure it out because this one prospectus contains all of a company’s annuities. I’ve considered these viewpoints, and typically I just ask you
John: Its challenging. And one of the things we do share with people is that the investment ideas we find appealing are clear and simple to understand. Perhaps “simple” isn’t the best way to describe it, but if you can’t understand something, you shouldn’t really invest in it. And we try to manage expenses and keep those down. Additionally, we are able to locate the expenses and identify a portion of the annuities. And you realize, “Well, when you do the math on it, that can be a pretty big number.” Or sometimes it’s difficult to even comprehend all the moving components.
Not because it’s not a wise investment or appropriate in every case, but generally speaking it’s not required. And occasionally we come across folks who believe that an annuity is the solution to all problems. I frequently reply, “It does serve a purpose, but it’s not a panacea for everything.” And you might wonder, “Is that the right place to be with things?” if you don’t understand all the moving parts in the annuity or any other investment you make.
Bridget: So heres a client situation. When my client’s husband passed away, the investment people called her right away and tried to sell her an annuity. This should be red flag city. Annuities seem to be saying, “This is too complicated,” as well. You cant figure it out yourself. Ill take care of it. Let me put my cape on. ”.
John: I disagree, saying that a lot of Wall Street seems to be saying, “You have to pay us to handle the investing part because you can’t do this yourself.” And there may be some merit to that, though not nearly as much as they would have you believe.
Bridget: Yeah, exactly. So the lack of transparency around them really bothers me. Furthermore, I believe that instant fixed annuities are acceptable; however, as soon as you enter the market, people will begin to ask, “Oh, yeah, but what about this? What about that? What about the other thing?”
John: Regarding your criticism of the lack of transparency, we’ve had people say things like, “Jeez, this sounds like a pretty good idea,” after attending seminars and receiving a free steak dinner. Theres no fees in it. It doesnt cost anything. ”.
John: I inquire, “So the insurance company doesn’t make any money on this? The person who sells it doesn’t make any money on this? Do they do all their work for free?” We are aware that the answers are no, but that is the lack of transparency you mentioned with things if we are unable to determine what we are paying for. I have a different but comparable story with the client. But taking your client situation. The husband passes away. So, should the surviving spouse receive an annuity? Possibly. Think about this situation. Let’s say that husbands have health issues, and perhaps the wife is only 70 years old, but everyone in her family has lived to be 98 years old or older.
“Listen, we went from two people, and we might need the money in a shorter period of time to now that I have a 30-year time horizon that I’m planning for, and I’m kind of concerned about running out of money,” could be a very reasonable place to have an annuity. ” That might perfectly fit. The problem is how it gets presented. And in so many cases, it doesnt. I had sort of the opposite. One of my clients recently rolled over her 401(k) into an annuity with a broker. I replied, “I’m not sure that’s the best course of action.” Lets have it analyzed. We work with an expert who only handles a few of these annuities.
“Well, it’s not that amazing, but these longevity benefits are actually pretty good,” he said, adding that you could withdraw the money and that it wasn’t an instant benefit. If your clients are concerned about living a long life, this is actually a really great deal. I returned to the client after that and said, “Hey, here’s the thing.” It’s okay for growing your money, but this is actually fairly solid for longevity. “Nobody in my other family has lived past the age of 82,” she continued. Im not planning to live any longer. Having money available at 95 is not on my radar. ” You go, “Okay, wait a minute. Completely the wrong situation. ”.
Transparency and attempting to address the appropriate issue are crucial. It can work, for sure, but what’s the difference? And I believe you probably do this as well, Bridget, but we could tell people, “Listen, if longevity is a concern for you, here’s what these income annuities look like.” The pros: you never outlive it. The cons: you lose some flexibility. On the other side, you got the bond ladder. We are unsure if it will continue for a full 100 days. We think so, but we don’t know. So you dont have that, but you have the flexibility. You can then make an informed decision based on what makes the most sense to you and what your main concern is. That’s what I believe our world is really lacking in general.
Bridget: Yeah. The fact that I see a lot of annuities in our IRAs is another concern I want to raise regarding them, even though there may be situations in which they make sense. For instance, I have all of my money in an IRA, and my main concern is running out of money. Alright, so one advantage of an annuity is that it allows for tax-deferred growth. Additionally, you receive the same benefit from an IRA—they don’t multiply. It’s not as though investing this in an IRA will yield twice the benefit. Thats not the case 99% of the time. In my opinion, having an annuity in an IRA or 401(k) is cause for concern. That’s just what we want people to be aware of and to be on the lookout for, to reiterate.
John: And well see people come in with that situation. And exactly to your point; you described it perfectly. “I’m concerned about my longevity, and this is the money I have,” they will say. ” Hey, it makes sense. We receive clients who are unaware that they genuinely own an annuity since it resembles mutual funds and they are unaware of the costs because annuity costs can be as low as 0. 25%, or they can be as high as 2. 25%. That has a significant impact on the investment side of things, so it’s crucial to have some degree of flexibility to consider both perspectives.
Bridget: Excellent! I believe now is a great time to conclude. In Chicago, Illinois, I am Bridget Sullivan Mermel, and I run a fee-only financial planning business.
John: And Im John Scherer. I own a fee-only financial planning practice in Middleton, Wisconsin. I belong to the Alliance of Comprehensive Planners, as does Bridget. If you enjoy the content on our program, visit acplanners.com. org to find an advisor in your area.
At Sullivan Mermel, Inc. We are fee-only financial advisors serving clients in Chicago and around the country. We are based in Chicago, Illinois. We communicate virtually using secure file transfers and video conferencing in addition to meeting in person at our Chicago office.
Keywords: annuities, bonds, retirement, income, investment, risk, return, fees, taxation, diversification
As you approach retirement securing a reliable income stream becomes paramount. Two popular options for generating retirement income are annuities and bonds. While both offer benefits, understanding their key differences is crucial for making an informed decision. This comprehensive guide delves into the world of annuities and bonds, analyzing their pros and cons to help you determine which option aligns better with your individual needs and financial goals.
Annuities vs. Bonds: A Detailed Comparison
What are Annuities?
An annuity is a financial product offered by insurance companies. It involves a one-time or periodic investment in exchange for guaranteed income payments over a specified period or for life. Annuities provide a steady income stream, regardless of market fluctuations, making them attractive for retirees seeking financial security.
Types of Annuities:
- Immediate Annuities: Payments begin immediately after the initial investment.
- Deferred Annuities: Payments start at a later date chosen by the investor, allowing for tax-deferred growth.
- Fixed Annuities: Offer a guaranteed fixed interest rate on the investment.
- Variable Annuities: Investment performance determines the payout, offering the potential for higher returns but also higher risk.
- Indexed Annuities: Payments are linked to a specific market index, providing growth potential with limited downside risk.
Pros of Annuities:
- Guaranteed income: Provides a predictable income stream for life, regardless of market conditions.
- Tax-deferred growth: Accumulated earnings are not taxed until withdrawn, allowing for potential tax savings.
- Principal protection: In most cases, the principal investment is protected, mitigating the risk of losing capital.
- Longevity protection: Outliving your savings is a major concern for retirees. Annuities address this risk by ensuring income even if you live longer than expected.
Cons of Annuities:
- High fees: Annuities often come with high upfront sales charges and annual expenses, impacting overall returns.
- Limited liquidity: Early withdrawals may incur significant surrender charges, limiting access to invested funds.
- Taxation on income: Annuity payments are taxed as ordinary income, potentially increasing tax liability.
- Complexity: Understanding different annuity types and their features can be challenging for some investors.
What are Bonds?
Bonds are debt instruments issued by governments, corporations, or municipalities. Investors lend money to the issuer in exchange for regular interest payments over a predetermined period. Upon maturity, the investor receives the principal amount back. Bonds are considered a relatively safe investment, offering a steady income stream and capital preservation.
Types of Bonds:
- Government Bonds: Issued by federal, state, or local governments, considered low-risk with predictable returns.
- Corporate Bonds: Issued by companies, offering higher potential returns but also higher risk.
- Municipal Bonds: Issued by local governments, often exempt from federal and state income taxes.
Pros of Bonds:
- Predictable income: Bonds provide regular interest payments, offering a stable income stream for retirees.
- Diversification: Bonds can diversify a retirement portfolio, reducing overall risk.
- Liquidity: Bonds can be easily bought and sold on the secondary market, providing access to invested funds when needed.
- Tax advantages: Municipal bonds offer tax-free income at the federal and state levels, enhancing returns.
Cons of Bonds:
- Finite income: Bond payments end upon maturity, requiring reinvestment for continued income generation.
- Interest rate risk: Bond prices fluctuate inversely with interest rates, potentially impacting returns.
- Default risk: Although rare, the issuer of a bond may default, resulting in potential loss of principal.
- Lower potential returns: Compared to stocks or other growth-oriented investments, bonds generally offer lower returns.
Annuities vs. Bonds: Which is Better for Retirement?
Choosing between annuities and bonds for retirement depends on individual circumstances and financial goals. Consider the following factors:
- Risk tolerance: Annuities offer guaranteed income and principal protection, appealing to risk-averse investors. Bonds, especially corporate bonds, carry higher risk but also potential for higher returns.
- Income needs: Annuities provide a predictable income stream for life, ideal for retirees with consistent income requirements. Bonds offer regular interest payments but require reinvestment to maintain income generation.
- Tax situation: Annuities offer tax-deferred growth, while bond interest is taxed as ordinary income. Municipal bonds offer tax-free income, which can be advantageous depending on your tax bracket.
- Liquidity needs: Annuities may have limited liquidity, while bonds can be easily bought and sold on the secondary market.
- Investment horizon: Annuities are suitable for long-term investors seeking guaranteed income, while bonds can be used for shorter-term income generation or portfolio diversification.
Both annuities and bonds offer valuable benefits for retirement income planning. Annuities provide guaranteed income and principal protection, while bonds offer predictable income and diversification. The best choice depends on your individual risk tolerance, income needs, tax situation, liquidity requirements, and investment horizon. Carefully evaluate your financial goals and circumstances before making a decision. Consider consulting a financial advisor for personalized guidance and recommendations.
Additional Considerations
- Fees: Compare the fees associated with different annuity and bond options. High fees can significantly impact returns.
- Inflation risk: Inflation can erode the purchasing power of fixed income investments like bonds. Consider inflation-linked bonds or annuities with cost-of-living adjustments to mitigate this risk.
- Diversification: Consider diversifying your retirement portfolio with a mix of annuities, bonds, and other asset classes to reduce overall risk and enhance potential returns.
Remember, there is no one-size-fits-all answer to the question of whether annuities or bonds are better for retirement. By carefully evaluating your individual needs and circumstances, you can make an informed decision that aligns with your financial goals and ensures a secure and comfortable retirement.
Fixed annuities share many similarities to bonds. These are agreements that insurance companies give to people in return for a premium deposit. Similar to bonds, multi-year guarantee annuities accrue interest over a predetermined period of time (usually three to ten years) at a predetermined interest rate. Please visit our Top Multi-Year Guaranteed Annuity Rates page to view the current available interest rates.
A bond is an investment that is essentially an I. O. U. issued by a business or government organization, in which the issuing body borrows money from investors for a predetermined amount of time—typically 10 to 30 years When interest is paid on the bond by the issuing entity, usually semi-annually at a fixed rate, a return is earned. Maturity is the process by which the investor’s principal is returned at the conclusion of the predetermined term.
Numerous businesses and governmental organizations are able to issue bonds. The best kind of bonds are Treasurys, which have the full faith and credit of the United S. government. Local governments issue municipal bonds, which are frequently free from municipal, state, and federal taxes. In terms of how they mature, corporate bonds are comparable to government bonds, but they carry a higher level of risk. Corporate bonds are appealing because they typically provide investors with a higher potential yield.
Another difference between a fixed annuity and a bond is that bonds typically pay out their interest earnings every six months. In most cases, there is not an option to allow those interest earnings to remain within the investment to grow and compound. In addition, the interest earnings on corporate bonds are fully taxable in the year received. By contrast, fixed annuities provide contract owners with many more options as to how and when they receive interest earnings. Fixed annuity interest earnings can be taken monthly, quarterly or annually – or they can be left within the contract to grow and compound. Any interest earnings left inside the contract to grow and compound are tax deferred until withdrawn, a significant tax planning benefit. Finally, annuities offer the ability to create a guaranteed lifetime income stream that can help support retirement income needs, a feature not available with bonds.
Give us a call today to find out more about your options and how annuities can help you meet your needs. We would be pleased to address all of your inquiries and offer any more details you might need.
The trade-off is that, usually speaking, the annuity gives you no flexibility. There are a few different approaches you can take, but they are usually rather costly. But I dont have my money anymore. What would happen if I found out I had some sort of bizarre cancer and decided I would rather have more money in the next three years rather than worry about it thirty years later?
You could receive $1,000 per month, or your payout, with an annuity for the rest of your life, but you’re kind of stuck with that. There’s not as much flexibility as there is with the bond ladder, where you can make different choices. Conversely, if you live to 108, that annuity will continue to pay out for as long as you live, but, generally speaking, the bond ladder doesn’t extend that far.
Bridget: People are interested in bond ladders and CD ladders now that CDs and bonds are profitable again, and we have an episode about that. However, we were interested in learning more about the specific distinctions between bond ladders, annuities, and bond funds. Thus, we’ll cover everything in today’s Friends Talk Financial Planning episode so you can decide what’s best for your circumstances. Welcome to my fee-only financial planning practice in Chicago, Illinois. My name is Bridget Sullivan Mermel.
Not because it’s not a wise investment or appropriate in every case, but generally speaking it’s not required. And occasionally we come across folks who believe that an annuity is the solution to all problems. I frequently reply, “It does serve a purpose, but it’s not a panacea for everything.” And you might wonder, “Is that the right place to be with things?” if you don’t understand all the moving parts in the annuity or any other investment you make.
John: Just because someone sells something doesn’t mean they understand how it operates. You could be an excellent salesman but not a very good analyst.
Should You Buy an Annuity? Retirement Planning
FAQ
What is better annuity or bond?
What is a better investment than an annuity?
Do rich people invest in annuities?
Are bonds better than annuities?
Both bonds and annuities can create a steady stream of retirement income, but there are trade-offs to each. Bonds often yield higher returns but come with certain risks. Annuities, as insurance products, provide a more predictable income stream. Understand their differences to help you structure a portfolio that aligns with your needs and goals.
Should you invest in a bond or an annuity?
Returns are predictable, potentially making it easier to plan your retirement budget. Bonds could offer better rates of return compared to the rate of return for an annuity. It’s possible to diversify across different types of bonds, i.e. corporate bonds, municipal bonds, government bonds and agency bonds. Bonds are relatively easy to purchase.
What is the difference between a bond and annuity?
With a bond, you lend money to corporations, municipalities, or governments which pay you regular interest payments for a fixed period, and then your principal investment is returned when the bond reaches maturity. Annuities vary in payment schedule and payment calculation methods, while bonds vary in maturity length and interest rates.
Are municipal bonds better than annuities?
Bonds could offer better rates of return compared to the rate of return for an annuity. It’s possible to diversify across different types of bonds, i.e. corporate bonds, municipal bonds, government bonds and agency bonds. Bonds are relatively easy to purchase. Municipal bonds are tax-exempt.