Annuities Vs. Bonds: Which Is Better For You?

When people talk about safe investments for retirement, annuities and bonds often top the list. So which one is better?

The reality is, it’s not an either-or decision. In fact, knowing how each works can help you design a more comprehensive retirement income strategy. Want liquidity? Think bonds. Want guarantees? Think annuities. Smart investors learn how to leverage both.

Bonds vs. annuities: An overview

Annuities and bonds both serve a similar purpose: creating reliable income. That’s what makes them particularly appealing to retirees and near-retirees.

• Bonds are essentially loans you make to a government or corporation. You lend them money, they pay you interest and you get your principal back at maturity.

• Annuities, on the other hand, are contracts with insurance companies. You give the insurer a lump sum or series of payments, and they promise to pay you income either now or later — sometimes for life.

Here are some of the primary similarities and differences between bonds and annuities.

Bonds and annuities are both conservative financial products

If your goal is protecting principal rather than maximizing growth, bonds and fixed annuities fit the bill. Bonds from stable issuers — think U.S. Treasurys or investment-grade corporate bonds — are considered low-risk.

Fixed annuities, which guarantee a fixed interest rate for a specified period, also guarantee your principal as long as the insurer stays solvent. Neither will make you rich, but both aim to keep your money safe while earning modest returns.

Bonds and annuities are both used as stable sources of retirement income

Bonds pay predictable interest and return your principal when they mature. By creating a bond ladder — buying bonds that mature at staggered intervals — you can generate income over time.

Fixed annuities, meanwhile, can be structured to pay monthly income for a set period — or for life.

Both investments can help supplement Social Security or other retirement income, and in both cases, the focus is predictability.

Bonds require less of a commitment than annuities

This is where bonds have a clear edge. They’re easier to buy and sell than annuities, though there’s some variance in their liquidity.

• Individual bonds can be sold on the secondary market before maturity. If interest rates have risen, you might take a hit on the sale price, but at least the option exists.
• Bond ETFs are even more liquid. They trade like any other exchange-traded fund, you can usually get your money out by the next business day.
• Treasurys are also very liquid. You can buy and sell them easily through TreasuryDirect or your brokerage account, often with no fees.
• Corporate and municipal bonds are a bit less liquid, but you can still offload them if needed.

Fixed annuities are more restrictive and illiquid by design. Most come with surrender periods of three to 10 years, and withdrawing early triggers penalties and possible market value adjustments (more on that shortly). Once you annuitize — that is, convert your contract into income — you typically can’t get your money out.

If flexibility matters, bonds win. However, it’s worth noting that most annuity contracts these days let you withdraw up to 10 percent of the account value without penalties — but if you’re under age 59½, the IRS may slap you with a 10 percent early withdrawal penalty. Bonds held outside of retirement accounts don’t have this IRS penalty.

Annuities can generate guaranteed income

What makes annuities special is their ability to guarantee income for life. That’s not just marketing — it’s baked into the mechanism of how these products work.

Annuities can make this guarantee because they pool longevity risk across all policyholders. Not everyone will live to 90 or 100, so insurers can afford to pay more to those who do.

But here’s the catch: You need a decent chunk of money to generate meaningful income with an annuity. If you annuitize $100,000 at age 65, you might get around $475 to $650 a month for life, depending on interest rates and whether you choose single or joint-life income. It’s supplemental income, not a full retirement plan.

Buying bonds, on the other hand, often has a much lower barrier to entry. Treasurys can be bought in $100 increments. Bond funds have low investment minimums. That makes them accessible to a much broader audience.

Of course, bonds can’t guarantee a lifetime stream of income — you’ll keep getting coupon payments only until maturity.

Bonds and annuities are impacted by interest rates

Interest rates drive returns for both products.

• When rates rise, new bonds and annuities offer better payouts.
• When rates fall, existing bond prices rise — but new buyers get stuck with lower yields.

Bonds are marked to market daily, so if rates spike, your bond’s value drops (at least on paper). Fixed annuities avoid that volatility by locking in your rate for a set term — your account value doesn’t get dinged when rates change.

Still, there are risks. If you buy a 10-year annuity today and rates soar next year, you could get stuck in a contract earning less than what new products offer.

You’ll also need to consider market value adjustments (MVAs). If rates have fallen, the MVA may work in your favor and boost your payout. If rates have risen, it may reduce what you receive. The exact impact depends on the terms of your contract, so it’s important to review the details before making a withdrawal.

Annuities have certain tax advantages

Taxes are another distinction. Bond interest is generally taxable in the year you receive it, unless it’s from municipal bonds, which may be tax-free.

Fixed annuities, however, grow tax-deferred. You don’t owe taxes on interest until you withdraw money, and part of each payment may be considered a return of principal rather than taxable income. For high earners or those who expect to drop into a lower tax bracket in retirement, this deferral can be a big advantage.

Bonds and annuities are more intertwined than you might think

Ironically, insurers rely heavily on bonds to make annuity payments — so bonds and annuities are more closely linked than most people realize.

Insurance companies collect premiums from annuity buyers and invest much of that money into large, diversified bond portfolios. The steady coupon payments from those bonds fund the income streams retirees receive from annuity payouts.

So why not skip the middleman and buy the bonds directly yourself? The answer comes down to risk transfer and pooling.

When you buy an annuity, you’re outsourcing interest rate risk and reinvestment risk to the insurer. They deal with fluctuating bond yields, maturing securities and market volatility. They also pool risk across thousands of policyholders. You, in turn, get a fixed and predictable stream of payments.

In other words, you could buy bonds directly for income, but there’s no guarantee your payments will last as long as you do. With an annuity, the insurer can deliver something an individual investor can’t easily replicate: lifetime income protection.

What makes more sense for you: Annuities or bonds?

The answer lies in your goals. If you want liquidity and the option to sell, bonds may be a better option. But if you value guarantees and simplicity, fixed annuities may edge them out.

• Annuities take longevity risk off your plate. Living to 95 is great — unless your portfolio runs dry at 85. An annuity can ensure income no matter how long you live, which bonds alone can’t do. While annuities aren’t risk-free — the insurer could go bankrupt — they’re backed by state guaranty associations up to certain limits.

• Annuities simplify planning. Instead of laddering bonds and constantly rolling over maturities, you can set an annuity to deliver predictable income every month without lifting a finger. Some retirees like the hands-off nature of it.

• Tax deferral can make a difference if you’re still working. Holding bonds in a taxable account means paying annual taxes on interest, which erodes returns. A fixed annuity lets the earnings compound untouched until you start taking distributions.

Of course, there are trade-offs. Fees can be higher for annuities than for buying individual bonds. You lose liquidity. And if inflation runs hot, fixed payments may lose purchasing power. That’s why many financial advisors recommend a mix — using annuities for a guaranteed income floor and bonds for flexibility.

Bottom line

Annuities and bonds can both add safety to a portfolio, but they aren’t interchangeable. Bonds are easier to buy and sell, require less commitment and give you more control. Fixed annuities provide stronger guarantees, lifetime income and some tax advantages, but at the cost of flexibility.

The smartest move usually isn’t choosing one over the other — it’s combining them. Bonds can cover short- and medium-term needs, while annuities can generate a paycheck replacement in retirement. A financial advisor can help you determine the right balance for your situation and ensure both work together as part of your broader financial plan.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.