bonds

Are Bonds Passé?

Not quite, but annuities can provide more income, plus tax advantages and longevity insurance.

Stocks provide growth, while bonds and other fixed-income instruments provide income and reduce volatility. That’s the traditional view of asset allocation. But today, most bonds pay low rates and produce much less income than they once did. The traditional wisdom should be revisited.

Fixed annuities of various types can replace bonds, because they can offer higher yields and tax deferral and, optionally, guaranteed lifetime income. All annuities are tax-advantaged; earnings are not taxed until you start taking money out.

Are you looking for a better-paying alternative to bonds and certificates of deposit?

Then consider a fixed-rate annuity, also known as a multi-year guaranteed annuity. Like a bank CD, it offers a set interest rate for a set period, usually three to 10 years. Rates today are usually significantly higher than those of a bank CD with a comparable term. For example, a five-year fixed-rate annuity from one company was offering a guaranteed annual yield of 3.45% for five years as of mid-August 2020 — compared to about 1.5% for the best five-year CDs, according to Bankrate. Fixed-rate annuities work well to fund an IRA, too. 

Pros: Besides offering competitive rates, fixed-rate annuities are a simple, straightforward product that makes comparison shopping easy. All of your deposit goes to work for you immediately. There’s some liquidity because many annuities let you withdraw up to 10% of your accumulation value annually without penalty.

Cons: There’s no growth potential beyond the guaranteed interest rate. If you cancel the annuity before the term is up, the insurer will charge a penalty.   Withdrawals before you reach age 59½ may be subject to an IRS penalty of 10% of the earnings that are withdrawn as well as ordinary income tax. 

Are you looking to secure guaranteed lifetime income so you won’t ever run out of money in retirement?

Lifetime income annuities are longevity insurance. They let you convert some of your savings into a personalized lifetime pension. You can buy guaranteed lifetime (or joint lifetime) income, beginning  immediately or at a future date. The former is called an immediate annuity; the latter is called a deferred income annuity.

Income annuities make the most sense for people who believe that they will enjoy longer-than-average life expectancy.  Of course, it’s hard to predict. You may feel that your life expectancy is subpar but end up blowing out the candles on your 100th birthday cake!

Pros:  You receive guaranteed lifetime income with tax advantages, as only a portion of the income is taxable; the bulk is nontaxable return of principal.  Here’s where the big advantage comes in: Once you’ve exceeded your life expectancy and gotten your entire principal back, your monthly income will still keep coming, even if you live past 100. At that point, your payments will become fully taxable.

Cons: No cash value. You’ve traded your savings for future income.

While lifetime income annuities are most popular, you can also buy an income annuity for a set period, such as 10 years. This can work well for someone who needs to fill an income gap until Social Security or an employee pension kicks in. 

Are you looking for long-term growth potential without any downside?

There’s one financial product that offers this: the fixed indexed annuity. It offers market-linked growth potential while guaranteeing principal. Indexed annuities credit interest annually based on the growth of a market index, such as the Dow Jones Industrial Average or S&P 500, usually with upside limits. But you lose nothing in down years.

Pros: Indexed annuities offer a “have-your-cake-and-eat-it-too” benefit, uniquely combining growth potential with guaranteed principal.  Over the long term, this approach is likely to outperform other guaranteed-principal products, such as fixed-rate annuities and CDs.

 Cons:  They’re not a good product for short-term holding periods because the interest rate fluctuates considerably. In years when the index is down, you won’t earn anything. Furthermore, these products are complex. Features, upside limits and crediting methods vary greatly, making apples-to-apples comparisons tricky. Withdrawals before 59½ may be subject to an IRS penalty of 10% of the earnings that are withdrawn plus ordinary income tax. 

Annuities are not insured by the FDIC. However, there is a form of insurance provided by state guaranty associations in case the insurer becomes insolvent. Coverage varies by state.

Annuities are guaranteed by the issuing insurance company. Therefore, it is important to check the insurer's ratings provided by agencies such as A.M. Best, Standard & Poor's or Moody's. These agencies grade insurers for their overall financial strength and their claims-paying ability. Be sure that the insurance company you go with is financially stable, as you will want it to be there in the future when you need it.

About the Author

Ken Nuss

CEO / Founder, AnnuityAdvantage

Retirement-income expert Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed and immediate-income annuities. It provides a free quote comparison service. He launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities.

Most Popular

Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
7 Best Commodity Stocks to Play the Coming Boom
commodities

7 Best Commodity Stocks to Play the Coming Boom

These seven commodity stocks are poised to take advantage of a unique confluence of events. Just mind the volatility.
September 8, 2021
Stock Market Holidays in 2021
Markets

Stock Market Holidays in 2021

Is the stock market open today? Take a look at which days the NYSE, Nasdaq and bond markets take off in 2021.
September 2, 2021

Recommended

Yes, Your 401(k) Has Its Perks, But It’s Not the Only Way to Save
how to save money

Yes, Your 401(k) Has Its Perks, But It’s Not the Only Way to Save

Tax diversification can play a vital role in stretching your retirement savings. Here’s how to achieve the flexibility you need with a three-bucket sy…
September 20, 2021
These 2 Emotional Biases Could Kill Your Retirement
Investor Psychology

These 2 Emotional Biases Could Kill Your Retirement

Are your emotions sabotaging your retirement plans? Some basic knowledge and careful introspection can go a long way toward avoiding major pitfalls.
September 20, 2021
Investment Strategies for the 4 Stages of the Economic Cycle
Markets

Investment Strategies for the 4 Stages of the Economic Cycle

The U.S. economy is cyclical in nature, surging ahead and pulling back in waves over time. Investors’ portfolios need to change with the rise and the …
September 19, 2021
How Exactly Do You Stress-Test Your Financial Plan?
retirement planning

How Exactly Do You Stress-Test Your Financial Plan?

Some tasks are not good for DIYers, and stress-testing your portfolio is probably one of them. Because individuals don’t have access to the same tools…
September 18, 2021