Retirement means making a lot of choices. Sometimes, those choices are pure fun, like the first places you’ll visit on your “bucket list” vacation tour. Often, though, your choices are more consequential — like how you’ll establish a stable income in retirement. While you may already have your 401(k), IRAs, and investment accounts in place, you might also be considering additional sources of steady income, such as annuities, bonds and CDs.
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Understanding the nuances of how each product works is essential to determining whether they’re right for your financial goals — or how they might even work together. But comparing the ins and outs of annuities, bonds and CDs can be tricky — which is why GOBankingRates connected with Chris Berkel, an investment advisor and president of AXIS Financial.
He helped explain how each product works and how they can come together like the parts of an orchestra to make beautiful music in retirement.
Before describing the nuances of annuities, bonds or CDs, Berkel emphasizes that purchasing one product doesn’t mean you must forgo the others. In fact, you can combine them to build multiple revenue streams that serve your needs.
“When thinking about retirement income streams, it’s more than any product; it’s how we put them together to make the portfolio best meet the needs of the client we’re serving,” he said. “Like any instrument in an orchestra — on its own, it can be very pretty and nice to listen to — but when you put everything together, the woodwinds, brass, percussion, strings — well, then you have something extremely special.”
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If you think of annuities, bonds and CDs as financial instruments, they’re ultimately working toward a symphony of stable income. Berkel said that each of them provides periodic payments, but they differ in how those payments are structured.
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Annuities: “Annuities are backed by an insurance company, and it’s the company that commits to make payments to the investor,” he said. “The payments the investor receives are typically part interest income and part return of principal.”
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Bonds and CDs: “For bonds and CDs, they are both from the same family, so to speak, so they pay a set interest rate — a ‘coupon’ — and then the principal is supposed to be paid back in full at maturity,” he said.
Bonds can be split into two large categories: Treasuries and non-Treasuries. What’s the difference between the two? Berkel described U.S. Treasuries as bonds that are guaranteed at maturity by the government, whereas no other bond is guaranteed — meaning you’re relying on the company you lend to being able to pay back your principal at maturity.
Berkel adds that CDs are unique as bank-issued products, which makes them similar to bonds. Since a CD is bank-issued, the FDIC guarantees the principal up to $250,000 per institution. He offers a hypothetical example of someone with a $500,000 CD at JPMorgan: “Only $250,000 of it is protected, and the rest is on the full faith that JPMorgan will pay you back.”
One of the common risks between bonds and annuities is that payments are typically fixed. Berkel says that means inflation, over time, will eat into your purchasing power.
There are also key differences to look out for. Insurance companies promise to pay you a fixed amount for a set period — typically the rest of your life. Berkel explains that if you live long enough, the portion of your payment made up of your principal could be exhausted. The insurance company will still continue paying the contracted amount until you pass away, even if the funds supporting those payments run out. Basically, you’re giving your money to that insurance company in exchange for a contract guaranteeing those payments.
Berkel notes that bonds and CDs typically offer better liquidity than annuities. With an annuity, you could be locked in with surrender charges over five, 10 or 15 years; however, you could buy a bond today, change your mind and sell it tomorrow.
“With bonds and CDs, the issuer has to make coupon payments to the bond owner, but that owner can change,” he said. “Annuities are a contract between two parties — you and the insurance company — and so that contract is difficult to break. For bonds and CDs, it’s very easy to sell a bond and get your money back if you need it.”
Ultimately, the best approach to creating your perfect symphony of retirement income is to find the right co-conductor — a financial advisor you trust.
“When it comes to what’s right for you, that’s not one-size-fits-all,” said Berkel. “We go through a lot of planning with the people we serve to make sure they have the right product mix in the right account structure for them based on where and how they’ve saved.”
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This article originally appeared on GOBankingRates.com: Annuities, Bonds, and CDs: How They Compare as Retirement Income Streams
