Annuities vs. Alternatives: Comparing Retirement Income Options

Retirement income strategies involve trade-offs

Since every retirement income strategy has pros and cons, many plans incorporate a combination of approaches rather than relying on just one.

For example, an income annuity can provide guaranteed income for life, but you’ll typically sacrifice some liquidity and growth potential in exchange for that certainty.

Bonds can generate predictable income and may help minimize portfolio volatility, but they generally provide income only for a specified period and remain subject to interest rate and credit risks.

Dividend stocks may offer the potential for both income and long-term growth potential. However, dividends aren’t guaranteed, and stock prices can fluctuate up or down.

Systematic withdrawal strategies give you control over your assets, but they also require you to manage market risk and the possibility of outliving your assets over time. If your investments decline in value while you're taking withdrawals, your portfolio may not last as long as you expected.

What certain income annuities may provide that other retirement income options generally do not

The defining feature of an income annuity is that it provides guaranteed lifetime income. This can be especially appealing if you’re concerned with outliving your retirement savings.

When you purchase an income annuity, the insurance company agrees under the terms of the contract to provide income for as long as you live, even if that’s longer than expected.

That’s why certain lifetime income annuities are referred to as longevity insurance - they help address the risk of outliving your income. As a reminder, you can’t withdraw from the annuity or get your money back except in the form of income payments. Other retirement income strategies, such as bond portfolios, dividend strategies, or systematic withdrawal plans, generally do not provide guaranteed lifetime income.

Guarantees are backed by the claims-paying ability of the issuing insurance company.

Annuities vs. bonds

Bonds generate retirement income by paying regular interest and typically returning principal at maturity. Some retirees build a bond ladder, which is a portfolio of bonds with staggered maturity dates designed to create a predictable stream of income.

The key difference is that bonds provide income for a defined period of time, while income annuities can provide income for life. You can structure a bond ladder to last 10, 20, or even 30 years, but it will eventually reach a final maturity date. An income annuity continues making payments for as long as you live.

That doesn’t mean one is necessarily better than the other. Bonds can provide stability, liquidity, and principal preservation, and annuities can help address longevity risk.

Annuities vs. dividend stocks

Dividend stocks appeal to many retirees because they can provide a stream of income while also offering the potential for long-term growth. If stock prices rise and dividends increase over time, your income may grow as well.

The trade-off is that neither the dividend nor the stock price is guaranteed. Companies can reduce or eliminate dividend payments, and stock values can fluctuate up or down.

That’s what makes dividend stocks and annuities difficult to compare. Dividend stocks may be better suited for discretionary spending, legacy goals, or long-term growth. But if you’re relying on income to pay for housing, food, utilities, and other essential expenses, the lack of guarantees can introduce additional risks you may not want to handle.

A helpful question to ask is: If the market declines and your dividend income drops, can your retirement plan absorb it? If the answer is no, an income annuity may provide a level of certainty that dividend stocks cannot.

Annuities vs. systematic withdrawals

A systematic withdrawal strategy involves taking money from your retirement accounts and investment portfolio. One common strategy is the 4% rule, which suggests withdrawing 4% of your portfolio in your first year of retirement and adjusting that amount for inflation in future years.

Many retirees like this approach because it’s simple and easy to remember. But one drawback that isn’t talked about much is sequence-of-returns risk.

If the market declines early in retirement and you’re simultaneously withdrawing money to cover living expenses, your portfolio may not ever fully recover. And as a result, you could run out of money earlier than expected, even with careful planning.

Unlike an income annuity, even the best systematic withdrawal strategy may not guarantee that your income will last for life. It’s good to have a systematic withdrawal plan, but you could also need a source of guaranteed income in case that plan fails.

When might an income annuity be worth considering?

In general, depending on your individual circumstances, an income annuity may be worth considering if:

• You want to supplement Social Security.
• You have a family history of longevity or expect to live a long retirement.
• You want more predictable income and less reliance on market performance.
• You wish to provide continuing income for a surviving spouse if something happens to you.
• You prefer a simpler retirement income strategy that requires less ongoing management.

How insurance and investments may work together

Insurance products and investments are designed to address different financial objectives. As you’ve probably noticed by now, most experts do not recommend that income annuities replace your entire investment portfolio. You still typically need other investments to provide growth potential, liquidity, and inflation mitigation. However, dedicating a portion of your assets to an annuity can help create some predictable income.

Rather than viewing these approaches as competing strategies, many retirement income strategies incorporate both.

For example, guaranteed income sources such as Social Security and, where appropriate, income annuities may help cover essential expenses, while investment assets remain available to support discretionary spending, legacy objectives, charitable goals, or future growth opportunities.

The appropriate combination depends on each individual's financial situation, objectives, time horizon, and tolerance for investment risk.

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