Bonds vs Annuities
Bonds are the traditional safe asset for retirement portfolios and many people own them without thinking about alternatives. Other than cash, it’s the only other safe option in retirement plans for people who want to de-risk approaching retirement. Investment companies and managers use bonds to balance portfolios and it’s so common that almost no one ever questions it. But, is it the best safe asset to use in retirement? It certainly deserves a second thought because annuities provide a few key advantages in several different retirement applications. I’m not ever going to tell someone to avoid bonds altogether but at the very least, most people would benefit from mixing it up a little.
The biggest issues with bonds can be seen in how most people own them. It’s not the bonds themselves that have a problem but bond funds that reveal the shortfalls. Bonds are basically a cash flow asset with a return of principal at the end. In a bond fund, managers are seeking to produce the highest cash flow and will buy and sell individual bonds regularly. The underlying price fluctuates with every trade so the value of the holdings is always different. The good thing about bond funds is that you can get out of them at any time because the value is calculated daily. You don’t have to wait until maturity but it might not be a good time to sell if the fund is down in value at the time.
The preferred way to use bonds is to own the individual bonds but then you aren’t as liquid. If you own the actual bond then you get regular interest payments and a return of principal at maturity. You can sell before maturity but market value is going to depend on interest rate changes since the purchase date. If rates are up then bond values are down so you’re better off waiting until maturity. Another issue with bonds is that it takes a lot of individual bonds to create a portfolio. Bond defaults are NOT non-existent and it happens more frequently the lower you go in credit rating. That’s why a lot of people just use bond funds because default risk is significantly diluted.
I started talking about this more than a dozen years ago. Bonds have literally been on a roller coaster ride. There was an all-time low in about 2016 where you didn’t get much interest and rates could go nowhere but up, which would decrease the market value of the bond portfolio. Rates climbed in 2018 and bond funds lost about 15% in the change. 2020 came along and rates crashed, increasing the value of bonds and offsetting some market losses in the Covid crash. If you want to know what my advice was six years ago you can go visit this little newsletter nugget, “Don’t Sell Stocks. Do This Instead.” Along about 2022 rates started to rise again and bonds took another hit. Sometimes it works in your favor and other times it doesn’t. It’s just another form of volatility that you don’t have to deal with in retirement.
The two biggest limitations with bonds are restricted cash flow and liquidity. Annuities provide an advantage in both areas by a significant margin. Everyone needs to remember that annuities are basically a bond fund backed by the insurance company’s reserves. An annuity is essentially an upgraded bond portfolio. Everything that you can do with a bond can be done with annuities and to a greater extent. Maximum guaranteed cash flow and more liquidity provide specific solutions for retirement.
Guaranteed income payments from annuities are at least 50% higher than interest payments from bonds. You can look at that two ways. Either, get more cash flow from the safe assets or allocate less money to the safe side. If you are focused on growth, legacy, or control of your assets then spending less money to get the same amount of cash flow is an efficient move. Others want or need to maximize income and that works to boost portfolios as well.
Deferred annuities like MYGAs or FIAs don’t require income payments to be taken. It’s just safe money and you are allowed to take up to 10% per year from the account without penalty. Yields are similar to bonds with additional benefits. The extra liquidity allows you to take higher withdrawals so you don’t have to worry when markets are down in value and even presents the opportunity for rebalancing the total portfolio.
Either of the above benefits make an exponentially positive difference in a portfolio over time. It stands to reason why most of my clients have purchased an annuity with nothing more than a portion of the bond allocation in a portfolio.
One more thing that I need to cover is the part about locking your money up into an annuity. There’s a psychological feeling that buying an annuity means you are losing control of your money. Well, in one way or another your money is locked up anyway and buying an annuity is no different. Lifetime annuities are obviously a lifetime commitment but deferred annuities are mostly in place for only five to ten years. Compare this to a lot of bond portfolios I’ve seen where individual holdings are stretched to almost 20 years in a ladder. Let the insurance company do that and just buy the annuity. Again, through contractual obligations, taxes, or volatility, your money is locked up one way or another.
Bonds are just fine and I’ll never tell you to eliminate them entirely but it is a good stepping stone to start analyzing how annuities can help in retirement. There are distinct advantages over bonds and for most people that’s the only change that needs to be made. Obviously if you own individual bonds one of the best options is to hold it until maturity, but if you own bond funds you should always be evaluating other options. A consultation would be good for anyone who wants to remove interest rate risk, increase cash flow, or enhance liquidity. Go ahead and get on my calendar if you want to talk about it.
Have a great weekend!
Bryan
Watch Episode 210: Bonds vs Annuities
Last Updated on January 16, 2026 by Bryan Anderson
Can you enlighten me on “structured products”?
I’ve had a few requests and it’s on the list of potential topics. I might move it up and do that soon.
Fixed indexed annuities and registered index-linked annuities are the “structured” products of the insurance world. “Structured” in this case means your return is based on purchases of options/derivatives. In an FIA, the issuer takes the anticipated annual yield on your money in its general account (after deducting 1.5 percentage points or more for overhead). That’s your “options budget.” It buys you a call option on an equity index. It might provide gains up to a cap of, say x% in a year, or a participation rate of xx%, depending on options prices, which vary with interest rates and volatility. (The option budget is never large enough to buy all of the potential annual index upside.) If the index loses value over a contract year, your option expires without value. Your account value stays the same (the gain on the general account keeps you whole) but you’ve got an opportunity cost–a MYGA yield. A RILA works the same way, but you can buy more potential upside because you’ve enlarged your options budget by selling part of the FIA’s natural downside protection. You get a buffer or floor instead of full no-loss protection. Volatility controls make both products opaque. FIAs and RILAs give you exposure to equities. MYGAs give you exposure to bonds. Without a political fix (the “Harkin Amendment”) in 2009, FIAs (or EIAs) would have been securities, like RILAs.