Bonds are corporate or government debt instruments. When you buy a bond, you’re lending a fixed amount of money to a corporation or public entity. In exchange, and based on their credit risk and the duration of the loan, they pay you a semiannual coupon followed by your money back at maturity. The value you’ll get from a bond is much more predictable than that from a stock because it’s defined unless (a) you decide to sell early, (b) the company defaults, or (c) the company cancels the arrangement early. Bond funds — which you’re more likely invested in than actual bonds — are portfolios of bonds.
Annuities, when purchased correctly, provide guaranteed income in retirement. You give money to an insurer upfront, and in exchange they promise you a steady amount of income each month starting at a predetermined date in retirement. It’s fixed for as long as you live and no matter what happens in the market. The amount of income you get each month depends on your age now, the age at which you start receiving income, your gender, and how much money you commit today.
The difference between annuities and bonds are as follows:
- Bonds provide interest (via coupon payments) and then return your principal at the end. Annuity payments on the other hand are a combination of interest and principal, making each individual annuity payment higher than a bond's coupon but with no principal repayment at the end.
- Bonds have finite durations, after which you will need to reinvest your money in order to keep generating interest. Annuities continue providing income forever, made possible by the pooling of longevity risk across participants (known as mortality credits).
- Bonds can be sold such that you get your money back with a gain/loss based on how interest rates have moved since your purchase. Many annuities, especially those offering the most value, cannot be sold.
- Bonds are issued by corporations. Annuities are offered by insurance companies.
Let’s take a look at some of their arguments next.