Bonds vs Fixed Annuities

A bond is an investment that is essentially an "I.O.U." issued by a corporation or government agency, where the issuing entity borrows funds from an investor for a specified period of time, typically 10 to 30 years. A return can be earned when the issuing entity pays interest on the bond, usually at a fixed rate and on a semi-annual basis. The investor’s principal is returned at the end of the specified term, which is called maturity.

Bonds are issued by a wide range of corporations and government agencies. Treasuries are the highest quality bonds and are backed by the full faith and credit of the U.S. government. Local authorities issue Municipal bonds and are often exempt from federal, state, and local taxes. Corporate bonds are similar to government bonds in their maturation process but come with what most would consider an increased amount of risk. The attraction of corporate bonds is that they generally offer investors a higher potential yield.

Fixed annuities share many similarities to bonds. They are contracts issued by insurance companies to individuals in exchange for a premium deposit. Like bonds, multi-year guarantee annuities earn interest at a predetermined interest rate for a specified period of time, typically 3-10 years.

However, there are some key differences between bonds and fixed annuities. The market value of a bond fluctuates with changes in interest rates, and if sold prior to maturity may be worth more or less than its original cost. Investors in individual bonds must also be concerned with default risk, the risk that a company or municipality will fail to make timely interest or principal payments when due and default on its obligations. Fixed annuities offer a lower risk alternative to bonds because the insurance company bears the underlying investment risk, shielding contract owners from market volatility concerns and default risk.

Now, here's some (what I consider) big differences on why a fixed annuity is typically a better option. Another difference between a fixed annuity and a bond is that bonds typically pay out their interest earnings every six months. In most cases, there is not an option to allow those interest earnings to remain within the investment to grow and compound. In addition, the interest earnings on corporate bonds are fully taxable in the year received.

By contrast, fixed annuities provide contract owners with many more options as to how and when they receive interest earnings. Fixed annuity interest earnings can be taken monthly, quarterly or annually – or they can be left within the contract to grow and compound. Any interest earnings left inside the contract to grow and compound are tax deferred until withdrawn, a significant tax planning benefit. Finally, annuities offer the ability to create a guaranteed lifetime income stream that can help support retirement income needs, a feature not available with bonds.

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