Alternatives to Annuities: How to Choose the Right Tool for Retirement

Planning for retirement means making sure you have enough money to maintain your lifestyle after you stop working. If you don’t prepare adequately, you risk facing financial hardships, or you may even need to lower your quality of life.

Fixed annuities are a powerful—and popular—retirement planning tool. They give you a safe way to safely grow your nest egg and accumulate what you need to live comfortably. Later, you can turn them into a steady stream of retirement income for life.

The advantages of annuities include:

• Guaranteed income. Annuities provide a steady stream of income for a specified period or for life, ensuring financial stability.
• Tax-deferred growth. Earnings in certain annuities accumulate tax-deferred, allowing the principal to grow faster without having to pay taxes until you withdraw money or receive disbursements.
• Protection from longevity risk. Annuities can help mitigate the risk of outliving your savings, offering you peace of mind.

But while there are clear benefits to annuities, they may not be for everyone. In this article, you’ll learn about 5 robust alternatives to fixed annuity contracts, how they compare, and how to decide which is right for you.

Note: Different types of annuities come with different features, pros, and cons. To keep it simple, this article will focus on alternatives to fixed annuities, the simplest and lowest-risk type of annuity.

1. Dividend-Paying Stocks

Dividend-paying stocks are stocks (shares) that you own in companies that return a portion of their profits to shareholders.

These stocks provide you with a dual potential benefit:

1. You own an asset (the stocks), which can appreciate in value if the stock's price increases.
2. You can also receive regular dividend income.

Here’s how they compare with annuities:

• Potential for growth. Stock prices fluctuate with the market, so your growth depends on the performance of the stocks you buy. Fixed annuities offer a guaranteed rate of return.
• Dividend income vs. annuity payments. Dividends are typically paid from the company's profits and can vary based on company performance; they are not guaranteed and can fluctuate or even be eliminated. Annuity payments are contractual obligations, so they’re guaranteed. Depending on the payout option you choose, payments can be for a set period or for life.
• Risk. Stocks are risky because their value is tied to market volatility. Fixed annuities are one of the safest investments for retirement as they provide guaranteed returns. On the other hand, their returns may not be as high as stocks, and there may be surrender charges or penalties if you withdraw your money early.

Not sure which is right for you? Consider these questions.

• How comfortable am I with market volatility? If you don’t mind the possibility of losing money, stocks may be appropriate for you. If you want to be sure you won’t lose money from your investment depreciating in value, fixed annuities are likely the better choice.

• Do I have the expertise or guidance to select dividend-paying stocks? Choosing stocks can be complicated. If you are confident you can pick winners, they may be a good option for you. If you’re not sure how to select stocks for your portfolio, a fixed annuity may be a more straightforward way to steadily grow your money.

2. Bonds and Bond Ladders

Bonds are debt securities issued by governments or corporations to raise capital. Investors lend money to the issuer in exchange for periodic interest payments plus the return of the bond's face value at maturity.

Bond ladders are an investment strategy where an investor purchases several bonds with different maturity dates.

As each bond matures, the principal is reinvested in a new bond, creating a "ladder" of bonds maturing at regular intervals. This can provide consistent income and reduce interest rate risk.

Bonds are often compared to fixed annuities because both are usually quite low-risk. Here’s how they compare:

• Predictability of income. Bonds and bond ladders provide predictable income based on the fixed interest rate of each bond. If you hold a bond to maturity, you know the return in advance. Similarly, fixed annuities offer guaranteed interest crediting rates and, if you annuitize, a guaranteed income stream.
• Interest rates and their impact. Bond prices move inversely to interest rates. If interest rates rise, bond prices fall, and vice versa. On the other hand, fixed annuity interest crediting rates typically rise with increases in interest rates.
• Liquidity concerns. Bonds are typically more liquid than annuities and can be sold on secondary markets (though prices may vary). Bond ladders provide periodic access to capital as bonds mature. Annuities typically face surrender charges if withdrawn early, making them less liquid.

Either one could be a good choice for you, but here are some questions to consider when deciding between bonds vs. annuities:

• How do current interest rates compare with annuity rates? Assessing this can help determine which option offers a better return potential, given the current economic climate. With higher interest rates, annuities may be better. With lower interest rates, bonds may be more attractive.
• Am I looking for short-term or long-term income streams? Bonds and bond ladders can be tailored for short to medium-term income, while annuities are more well-suited for long-term income needs.

3. Real Estate Investment Trusts (REITs)

REITs are companies that own, operate, or finance income-generating real estate.

They operate in various real estate sectors, including commercial, residential, retail, and others. They provide a way for individual investors to invest in large-scale, income-producing real estate without having to buy property directly.

By law, REITs are required to distribute at least 90% of their taxable income to shareholders annually in the form of dividends. That makes them, similar to annuities, a potentially useful way to generate retirement income.

Here’s how they compare directly with annuities:

• Diversification of portfolios. REITs allow investors to gain exposure to real estate assets without the need for significant capital or the hassles of direct property management. They can diversify a portfolio by adding a different asset class. Similarly, annuities provide a stream of income or future payments based on contractual terms, which can also help diversify a portfolio.
• Potential dividend income vs. annuity payments. REITs offer potential dividend income, which can vary based on the performance of the underlying real estate assets and market conditions. Fixed annuities deliver regular payments of fixed value, providing more predictable income.
• Liquidity. Many REITs are traded on major stock exchanges, allowing investors to buy and sell shares easily—they’re highly liquid. Annuities typically have surrender charges if withdrawn early and are generally less liquid than traded REITs.

Wondering if an REIT is the best investment option for your retirement savings? Ask yourself these questions:

• How do I feel about investing in real estate indirectly? If you like the idea of investing in real estate, REITs could be a good choice. If it makes you uncomfortable to invest in real estate, annuities are a better option.
• What types of REITs (e.g., commercial, residential, industrial) align with my investment goals? Different REITs have varied risk profiles, potential returns, and growth prospects, so aligning with your objectives is crucial.

4. Mutual Funds

Mutual funds are investment vehicles that pool together money from many investors to purchase a diversified portfolio of stocks, bonds, or other securities.

Each fund is overseen by a fund manager or a team of professionals who decide how to allocate the pooled resources based on the fund's objectives.

Here’s how they compare with annuities:

• Diversification benefits. Mutual funds offer diversification as each fund holds a variety of securities, spreading risk across multiple investments. Annuities can add diversity to a retirement portfolio that is focused on stocks and other securities.
• Potential returns and risks. The return of mutual funds is based on the performance of the underlying assets—they offer the potential for higher returns compared to some fixed annuities, but they also come with market risks. In contrast, fixed annuities offer guaranteed returns.
• Management fees. Mutual funds often come with management fees (expense ratios) that are deducted from the fund's assets. Some fixed annuities have administrative fees, but many don’t. For example, fixed annuities at Canvas Annuity come with zero account charges or fees.

If you’re trying to decide between mutual funds vs. fixed annuities, consider these questions:

• How active do I want to be in managing my investments? Mutual funds are typically managed by professionals, so investors can be passive, but you do need to choose which fund to invest in. With fixed annuities, once you’ve signed your contract, there's generally no management needed on your part.
• What are the tax implications of my investment choices? Mutual fund distributions can be subject to capital gains tax, while the interest in fixed annuities grows tax-deferred until withdrawal. When you withdraw it, you’ll usually pay ordinary income taxes on earnings. Read more about the tax implications of annuities here.

5. Certificate of Deposits (CDs)

CDs are deposit accounts offered by banks with a fixed term, typically ranging from a few months to several years.

They offer a fixed interest rate over the term and return the principal amount when the term ends. Generally, withdrawing funds from a CD before its maturity will result in a penalty.

Here’s how they compare with annuities:

• Safety and FDIC insurance. Deposits in CDs are insured by the Federal Deposit Insurance Corporation (FDIC) up to the legal limit, which, as of this writing, is $250,000 per depositor, per bank. Annuities are insurance products and are not FDIC-insured. 
• Interest rates. CDs offer fixed interest rates that remain constant over the term of the CD. Similarly, interest rates for fixed annuities are guaranteed for the term of the annuity. Rates for both products can be influenced by various factors, including the length of the term and the federal funds rate set by the Federal Reserve.
• Liquidity and maturity terms. CDs have defined maturity terms, and withdrawing before the term ends usually incurs penalties. Fixed annuities might have surrender charges for early withdrawals, especially in the initial years. Some might offer periodic penalty-free withdrawals.

Trying to decide between CDs vs. annuities? Questions to consider include:

• Am I looking for a short-term or long-term safe haven for my money? While CDs are a good option for safely growing money over the short term, annuities are typically better for longer-term commitments.
• How do CD rates compare with annuity rates? CDs typically have lower rates than annuities.

Annuity Alternatives for Every Retirement Plan

The key to retirement planning is to build a portfolio that simultaneously grows your nest egg while not exposing you to too much risk. You want growth while also playing it relatively safe.

Annuities can do that, but they’re not the only option. The annuity alternatives listed above give you a range of options that can help you make sure you are well set up for life after work. Each has pros and cons, so make sure you evaluate each option carefully.

Fixed annuities are powerful because they offer you a great mix of growth and safety.

Your retirement savings grow at a steady, fixed rate. Then, later, you can choose to turn them into a steady stream of income.

Ready to learn more about the benefits of annuities or to compare the best annuity rates?

Reach out to one of our license reps and learn about all of the features Canvas Annuity offers to help you feel financially prepared for retirement.