Money is a common source of stress. In fact, most Americans worry about money even more than they worry about their family or their health, and the Americans who worry about finances the most are part of the millennial generation.
According to global investment management corporation BlackRock, their Global Investor Pulse survey found that the concept of retirement planning leads many to fear the uncertain future. However, the survey also showed that those who started saving up for retirement early reported better well-being than those who did not.
They likened saving up for retirement to exercising, considering that both have short- and long-term benefits and can reduce stress. When weighing options for sources of retirement income, many turn to either annuities or savings bonds. While the two may seem similar at the outset, they differ in a number of ways.
What are annuities and savings bonds?
An annuity is a financial product that takes an investor’s premiums and allows for tax-deferred growth and a steady flow of income, either throughout a set period or for the rest of one’s life. The main benefit annuities provide is the promise of long-term income, especially during retirement. You can purchase annuities from insurance companies or other financial institutions.
There are many types of annuities, but all of them can either be immediate or deferred, which means you can choose to begin receiving your annuity payments immediately or later. You could also choose from fixed, fixed indexed, or variable annuities. Fixed annuities guarantee a set rate of interest for a set period, while fixed indexed annuities guarantee a minimum rate of return but earn interest based on a market index. On the other hand, variable annuities earn interest through investments you choose, which means that you wouldn’t be guaranteed a return. If your investments do well, then you could see your investments grow, but you can also lose your money in a variable annuity.
Savings bonds are popular savings solutions because they are fully backed by the federal government. Savings bonds are considered zero-coupon bonds because they earn interest every month, but the investor does not receive that interest until the bond matures or is redeemed. It is always recommended to check with a tax professional, but with most savings bonds, you wouldn’t need to pay state and local taxes on interest, only the federal tax once you redeem your bond.
Savings bonds in the US are categorized into I savings bonds and EE savings bonds. The I savings bonds, which exist only electronically, came after the EE savings bonds, which are printed on paper. You can purchase a savings bond from the treasury website, your bank, your credit union, or other financial institutions. However, the I and EE savings bonds differ in price. You can purchase an EE savings bond at half their nominal value, while you can only purchase an I savings bond at their nominal value. With either I or EE savings bonds, you could earn a fixed interest rate for up to 30 years.
How are they similar?
Both annuities and savings bonds are considered part of the “fixed income” asset class, which means that investors are paid a fixed interest or dividend payments until the investment matures. The idea of a fixed income is most appealing to retirees or younger people already planning their retirement period, although anyone can purchase an annuity or savings bond. Many people buy savings bonds for young relatives as birthday presents in the belief that the bonds can put them through college once they mature.
Savings bonds and annuities are also tax-deferred, at least until you redeem your bond or start receiving your annuity payments.
A New York Times article from March 1984 touted the use of savings bonds as an annuity because someone who has invested in savings bonds would be able “to redeem a portion each year after retirement is required.” It may sound appealing, but is that really all there is to it?
How are they different?
Annuities can guarantee lifelong income, while savings bonds last only until maturity. When you buy an annuity, you know that you will receive payments with interest either now or later. Savings bonds, like any type of bond, have an expiration date and can be redeemed only once they mature. If you want to earn more from those bonds, you can just reinvest what you receive in new bonds.
Annuities can be purchased from insurance companies, banks, and other financial institutions while savings bonds come from the government. Many believe that savings bonds are safer options because they are the responsibility of the government, but risk is always present whether investing with the government or a private financial institution. If the government defaults, in which it cannot pay its debts, the principal may still be lost. Funds in annuities, however, are protected by state guaranty associations in the event that an insurance company defaults or goes bankrupt.
Annuity payments are a combination of interest and principal, while savings bonds provide interest with principal upon maturity. Each annuity payment you receive is part interest and part principal, which means you won’t receive your principal back at the end of your annuity period unlike if you were to have a savings bond. However, while you will always receive the proceeds of a bond in a lump sum, you can choose to receive annuity payments either as a lump sum, or split at a frequency of your choice.
Annuities and savings bonds have different rates of return. Your annuity’s rate of return would depend on the type of annuity you choose to purchase. In contrast, savings bonds are known for their low rate of return. According to personal finance website The Balance, it’s possible for your savings bond to take up to 20 years to fully mature to double their original value under the rate of return set by the US government. Therefore, if you are planning your retirement and you are looking for your money to grow, a savings bond might not be the best option. As of April 2020, the guaranteed fixed rate for a Series I savings bond is only 0.20%. On the other hand, High Interest Annuities offers fixed interest rate annuities at up to 3.85% and the money is not locked in nearly as long as in a savings bond!
So, which one’s best for you?
According to Forbes Magazine, annuities outperform bonds in investment portfolios. An analysis by retirement researcher Wade Pfau, Ph.D. found income annuities “outperform bond funds as a retirement income tool because they offer mortality credits.”
Savings bonds and annuities may be popular choices for earning a retirement income for various reasons, but only you can say which would fit your lifestyle and help you reach your income goals.