Bonds Cannot Match Security & Guarantees of Annuities

In “Comparing Annuities to Bonds,” Bob Carlson of Investing Daily questions whether you can get the same guaranteed retirement income with bonds as you can with immediate annuities.  Despite the advice of financial advisors, economists, and even the federal government, only a small amount of people use part of their retirement savings to purchase an immediate annuity.  The most popular reasons given for this are that they don’t want to give up control of their money, they can’t easily take money out in a tough financial year, they don’t want to lose high returns should we enter into a bull market, and there is often no money to be left to heirs with an immediate annuity.

While these excuses for not buying an immediate annuity are all true in some regard, they are also the main reason that reputable advisors recommend using only a portion of one’s savings to buy their immediate annuity.  They are not reasons to not buy one at all.  Immediate annuities are great because they transfer the risks of living a long life and bad stock market returns away from you onto the insurance company.  The article gives the results from a study recently done by Michael Edesess of Advisor Perspectives looking to see if bonds could offer the guarantees of immediate annuities without the perceived drawbacks.  In summary, no they cannot and here’s why.

The study did find that rates for long-term bonds would be competitive with current fixed annuity rates.  But traditionally, people are advised to ladder their bonds for many reasons.  These laddered bond returns are much lower than those you would currently get with fixed immediate annuities.  When comparing an immediate annuity with a 30-year treasury bond, Edesess found that they would offer comparable returns only if interest rates stayed about the same.  But if interest rates rise, which everyone is hoping they do, the value of the bond will decrease and it becomes a much worse deal than the immediate annuity.

You must also take income taxes into account when looking at your future money.  Until you reach your life expectancy, a part of your annuity payments will be tax-free.  Some people estimate that it is around 75% of your payment that will be tax-free.  Once you reach your life expectancy, all of your distributions are taxed.  Your bond interest is taxed as ordinary income and since you mostly receive interest payments in the early stages, you will get less tax-deferral.  The amount of your payments that is tax-free will grow as the age of your bond grows though.  The article concludes that bonds will not match the security and guarantees offered with immediate annuities in your retirement.  Using a portion of your savings and purchasing an immediate annuity gives you a good income base off which to start your retirement.

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