Retirees are faced with an immediate problem of income replacement. The choices are an Annuity, Bond Ladder or Balanced Portfolio of Stocks and Bonds. Does Annuity make sense where it basically returns your money with a low level of guaranteed interest? The annuity company needs to make profit which comes out of ones return. Only the most risk averse retiree should buy annuities. Right or Wrong?
Academic analyses have shown that annuities do a better job than bonds, whether in a ladder or funds in a balanced portfolio of stocks and bonds, at both minimizing the change you run out of money and maximizing the legacy you can leave behind. Here’s an article that discusses others’ work as well as our own.
What annuities do that bonds don’t is provide mortality credits (access to other people’s money if you live longer than them) and free up your principal. In a bond ladder, you have to lock away a lot of money to generate enough interest to live off of, whereas you can put less money into an annuity to get the same income as your principal is returned to you along with interest.
Yes, annuities are for the more risk averse out there since you’re paying insurance companies to take on market and longevity risk for you. Generally, if you’re someone comfortable with just stocks, I’d say annuities aren’t right for you. But if you’re invested in bonds and your goals are to minimize the risk of running out of money while maximizing your legacy, annuities do a better job than bonds.