Savings accounts and bank certificates of deposit are dependable ways to accrue interest over time. However, bonds in your portfolio might not accomplish this and there might come a time when you need to navigate away from them in favor of the advantages of annuities.
For example, during times when the Federal interest rates increase, bond values operate inversely and decline. During these times, investors who rely on bonds for a steady stream of income may wonder if allocating away from bonds is a better safeguard. Whether this is a good idea depends on timing and how much time an investor has before retirement.
Just because interest rates rise doesn’t mean bonds are not a viable option for investors. If the duration of exposure is between 1-10 years, the investor can reinvest their principal payments as their bonds mature and rates rise. However, for some investors, annuities are more appealing because they can be more stable.
You can see how choosing to navigate from bonds to annuities depends on multiple factors. Below, we detail some of the questions you should ask yourself if you’re considering switching from bonds to annuities.
Annuities vs. Bonds: An Overview
Annuities and bonds are popular options for anyone looking to build a dependable stream of income. However, to determine when to shift from bonds to annuities, one must first understand how they differ.
Annuities provide an income for a certain period or for life depending on the product you purchase. With bonds, the investor loans money and accrues interest payments for fixed periods of time. Afterwhich, the principal gets returned. Typically, bonds pay higher yields than annuities. However, there are scenarios when an annuity makes more sense and can pay a higher interest.
Annuities and bonds are both considered to be in the fixed-income asset class. However, bonds are more commonly used since they trade similar to stocks and usually feature a higher earning potential than annuities.
Annuities
Annuities are not investments. They are financial products that provide monthly payments over certain time periods typically as guaranteed income for life. These financial products are typically used as income for retirees and they are created and sold by insurance companies.
Annuities are essentially long-term contracts between an insurance company and an annuitant. You invest money either as a lump sum or over time and in exchange you get a guaranteed income in periodic payments.
Bonds
Bonds are different from annuities in that they are investments and they provide regular interest payments. After these interest payments, the principal is returned to the investor. Bonds are issued by corporations, municipalities, and governments and you can think of them as an I.O.U. between an investor and another party. The investor becomes the lender and the company pays you interest for the life of the bond. When the bond matures, you receive your initial investment back.
High-quality bonds have been common among conservative investors because they offer a steady return and low risk. The biggest difference between bonds and annuities is that when you buy a bond, you receive interest payments for a set period of time, not your lifetime like annuities.
Understand the Purpose of Your Portfolio
Some annuities are better-suited for replacing your bonds than others. You need more income in the short-term. In this case, an immediate annuity would be best. On the other hand, you might want to achieve some of the tax-deferral benefits that annuities can provide. In this case, a deferred annuity would suffice. Understanding the purpose of your portfolio will help you make the correct choice when it comes to the type of annuity that fits your needs. Annuities can be complex, so having a trusted advisor at your side is critical.
Speak with the Right Financial Advisor
Speaking with a financial advisor about your next moves regarding bonds and annuities shouldn’t be a difficult task. Annuities feature various structures and deciding when to switch to them from bonds is a matter of timing. Protected income streams, principal protection, and insured death benefits all add layers to the decision-making process.
Before moving from bonds to annuities, investors should consider their reason for doing so and whether the particular type of annuity they’re considering will work. Income annuities might work for people who are already retired but they don’t make much sense for someone who is trying to accumulate interest and achieve the tax-deferral benefits other income annuities offer.
Annuities can be matched to the duration of the buyer’s life, meaning they can guarantee income. Because some types of annuities are uncorrelated with capital markets, their payout is guaranteed and does not fluctuate with the market. They might also offer higher cash flows than bonds.
Consider Pros and Cons of Variable and Fixed Annuities
Annuities might be suitable for retirees or those nearing retirement if they want to generate income in a rising rate environment. However, it’s important to note that this strategy does not apply to variable annuities. These annuities are subject to market fluctuations and they don’t feature secured incomes. For those who want the primary benefits annuities provide, variable annuities are not the best option. For those who want some market potential without the risk of losing their principal, fixed-indexed annuities might be the best option.
Don’t Give Up On Bonds
As with any financial decision, it’s always best to temper your expectations and understand that no one financial product or investment is the best solution all the time. California bond insurance have their purposes within retirement plans and no one should eschew them entirely. When lack of liquidity and costs overshadow the benefits of annuities, it’s time to consider rethinking moving from bonds to annuities.
Annuities also offer limited growth potential. For this reason, maintaining a bond position can be a sound strategy. However, in this case, the investor should still ask what type of bond they should hold. If someone has a nonqualified annuity they might do well to look at short-term municipal bonds that are investment-grade or better. Book yields are an important consideration when determining the best bonds to hold. The bonds with the highest book yields and qualities should be the ones that the investor keeps.
As with any financial scenario, you should look at the broader economic outlook to determine the best course of action.