Annuities vs. Bonds: What is the Difference & Which is Better for You?

Annuities and bonds are both purchased ahead of retirement to secure retirement income but there are some critical differences.

Choosing the right one depends on the investment and retirement goals of the individual.

So what are the basics of these popular investment vehicles and which may be the right choice to help you plan a secure retirement? Read on!

What Are Annuities?

Annuities are issued by insurance companies and are a popular long-term tool for retirement planning.

There are a few key reasons for this popularity, namely guaranteed income and tax deferral.

First, it’s important to understand the different "phases" of an annuity and when someone could receive the benefit of guaranteed income.

Before retirement, you purchase an annuity to help you grow assets (this is known as the "accumulation phase"). Insurance companies offer several options for helping you increase your pre-retirement savings depending on your risk appetite. One of the more popular types of annuities for conservative growth is called a multi-year guaranteed annuity, or MYGA.

A MYGA is a deferred, fixed annuity. You can purchase a MYGA with either a lump sum (single premium) or many payments over time (flexible premium). In exchange for your premium, an insurer will give you an annuity contract with a guaranteed rate of return that is locked in for the duration of the contract, usually three, five, or seven years.

For more adventurous investors with higher risk tolerance who are looking for higher yields, companies may also offer variable annuities, whose performance is linked to stock market funds. There is also an annuity with a mixture of guaranteed and non-guaranteed features called a fixed-indexed annuity.

A fixed-indexed annuity has returns linked to an index, such as the S&P 500. While crediting rates on fixed MYGAs are guaranteed, results from fixed-indexed and variable annuities fluctuate depending on the performance of the linked index or underlying funds. The second phase for all annuities is the "distribution phase." This is where retirees choose to receive a series of payments that are guaranteed by the insurer.

This guaranteed income stream is a unique feature of annuities and one of the main reasons why they are popular. Annuities that provide the potential for lifetime income during this phase are also called "retirement annuities." They are designed to reduce longevity risk or the risk of outliving your money.

Another reason for the popularity of annuities is their tax treatment. Annuities grow money on a tax-deferred basis, meaning that you do not pay any taxes on the annuity’s gains until you decide to begin taking withdrawals. This differs from other taxable investments like CDs and mutual funds where you need to pay taxes each year on any gains credited to you.

Tax deferral is an important benefit, especially for retirees who are in a lower income tax bracket after retirement when they start receiving their stream of income. In that case, tax deferral means you pay less in taxes on that money overall and keep more of the gains for yourself. For these reasons, annuities can be an integral part of a retirement portfolio.

What Are Bonds?

When you buy a bond, you’re essentially loaning your money to an entity for a set period of time. These bonds are debt instruments typically issued by individual companies or governments to help fund their expenses.

These entities take on “debt” in the form of bonds and pay the buyer what is called an “interest coupon,” which is the annual interest rate paid as a percent of the face value. The return you get from a bond is predictable and guaranteed by the issuer. The only way you would not get paid the promised rate is if you decide to sell early, the company defaults, or the company cancels the arrangement early.

Bond funds, the more popular way for the public to invest in bonds, are portfolios of bonds. Bond funds have a fund manager who uses the money deposited into the fund to buy a wide assortment of individual bonds. Because of this "pooling" of bonds in the fund, investing in bond funds is usually safer and easier than owning individual bonds.

There are two ways to make money by investing in bonds.

• Hold your bonds until their maturity date and collect interest payments on them. Bond interest is usually paid twice a year.
• Sell them during the term of the bond at a price that's higher than what you pay initially.

Bond prices and interest rates move in opposite directions. So if interest rates rise, bond prices fall and vice versa. Those movements, along with rising or falling inflation, can directly affect the performance of bonds you own.

Bond prices can rise for two main reasons. If the company or entity issuing the bond improves its risk profile (its financial situation gets stronger), then there is an increased chance that it will be able to repay the bond at maturity, and the price of the bond can rise. Also, if interest rates on newly issued bonds go down, then the value of an existing bond that was issued at a higher rate goes up.

Bonds for Retirement Income: Pros and Cons

Looking to fund a portion of your retirement income using bonds?

There are a few pros and cons you should understand before taking the plunge.

Pros

• Returns are predictable, potentially making it easier to plan your overall income picture.
• The different types of bonds can offer risk diversity, i.e. corporate bonds, municipal bonds, government bonds, and agency bonds.
• Municipal bond gains may be exempt from federal income taxes.

Cons

• Historically, bonds have provided lower long-term returns than stocks.
• Income payments only last for a set schedule, until the bond reaches maturity.
• If the entity issuing the bond defaults, you could lose interest payments and your initial investment.
• Bond prices and yields fluctuate as interest rates change, making income less predictable

Annuities for Retirement Income: Pros and Cons

Annuities are built to help ensure a secure and worry-free retirement – but they are not without risk!

Pros

• Annuities are singularly unique in their ability to provide guaranteed lifetime income for you and/or your spouse.
• Gains on annuities are tax-deferred, meaning you won’t pay taxes until you begin taking distributions.
• Fixed annuities can offer a predictable rate of return, while indexed or variable annuities can pay higher returns if you are willing to accept more risk.

Cons

• During the accumulation phase of annuities, there are typically surrender charges that are assessed for early withdrawal of our money. Some companies, like Canvas Annuity, allow up to 10% penalty-free withdrawals per year.
• Variable annuities and those that feature lots of bells and whistles (riders) can come with hefty fees.
• Some annuities can be complex and require consultation with a financial advisor

Which is Right for You?

Choosing the right products to help build a solid retirement portfolio and distribute the money correctly and appropriately in retirement can be tricky. Both bonds and annuities provide income but do so in different ways.

Factors to consider include expected expenses, including health care, risk tolerance, and emergency liquidity.

These and other factors should guide your purchasing decisions. And including a licensed agent and/or investment professional in our decision-making is always a good idea.

If you are nearing retirement and would like to place some of your retirement savings in a guaranteed product that features great returns, check out Canvas’ fixed annuities. Canvas annuities feature some of the most competitive rates in the country, and you can make your purchase 100% online or with the help of a licensed contact center agent.