Alternatives to Annuities: Options for Income in Retirement

Best Alternatives to Annuities

Annuities may not suit every financial plan. The best alternatives allow you to tailor your strategies to your financial goals and risk tolerance. There are a handful of financial products that fit that bill.

Examples of Popular Annuity Alternatives

• Treasury bonds
• Certificates of deposit
• Dividend-paying stock funds
• Retirement income funds

But annuities still offer unique features — such as a guaranteed lifetime income — these alternatives may not provide. Before you buy an annuity, it’s wise to consider all options available to you to be confident in your decision.

You need to identify and prioritize your objectives. Most investors are focused on some combination of ensuring liquidity, preserving capital, generating income, fueling growth and fostering diversification. I recommend working with a fiduciary financial advisor to complete this exercise. He or she can help you assess things in a holistic, risk-focused manner. 

Thomas J. Brock, CFA®, CPAInvestment, Corporate Finance and Accounting Professional

Thomas Brock, CFA®, CPA, is a financial professional with over 20 years of experience in investments, corporate finance and accounting. He currently oversees the investment operation for a $4 billion super-regional insurance carrier.

Alternatives to Fixed Annuities

Bonds and certificates of deposit are the most commonly mentioned comparisons to annuities, but comparing annuities to CDs or bonds is not apples-to-apples.

Typically, CDs are seen as shorter-term investments and their interest is taxed annually. On the other hand, annuities are longer-term investments that offer tax-deferred growth. 

Government bonds offer interest payments and return of principal at maturity, while annuities can provide periodic payments, often for retirement income.

A Quick Comparison of Annuities, CDs and Government Bonds

Type	Taxation	Principal Protected?	Interest
Fixed Annuity	Tax-deferred growth		Preset/guaranteed
Government Bond	Interest income may be taxed or tax-free		Most pay fixed rate of interest, but subject to interest rate risk
Certificate of Deposit	Interest income taxed		Preset/guaranteed

In addition to bonds and CDs, retirement income funds and dividend-paying stocks are worth evaluating as alternatives to an annuity.

Government Bonds vs. Fixed Annuities

U.S. government bonds are a safe and stable option for retirees seeking a dependable cash flow. They offer a guaranteed return of principal plus interest and come in different types with varying yields. While they provide flexibility and diversification, they are less predictable than a fixed annuity.

Fixed annuities are “much more of a fixed, predictable product, whereas your general investment world stocks and bonds and mutual funds and ETFs go up and down and are not predictable,” Andrew Rosen, president of investment management firm Diversified LLC, told the Annuity.org Podcast. 

The Bottom Line

• Ideal For: Risk-averse retirees seeking a reliable income stream
• Pros: Flexibility, stability, guaranteed return of principal plus interest
• Cons: Not as predictable as a fixed annuity

Certificates of Deposit vs. Fixed Annuities

Certificates of deposit (CDs) offer safety, predictable returns and diverse maturity options, making them a top alternative to fixed annuities for risk-averse investors seeking a steady income stream. 

CDs have shorter terms and lower early withdrawal penalties than annuities, making them more liquid and flexible. They are savings products with higher interest rates than traditional accounts and are backed by FDIC for up to $250,000 (up to $500,000 for joint accounts). CDs have a guaranteed rate of return and principal.

The Bottom Line

• Ideal For: Risk-averse investors seeking a steady income stream
• Pros: Shorter terms and lower early withdrawal penalties than annuities
• Cons: Generally pay a lower interest rate than annuities

Retirement Income Funds vs. Fixed Annuities

Retirement income funds (RIFs) offer flexibility and control over investments with customizable portfolios and adjustable income withdrawals. 

Unlike annuities, RIFs allow you to benefit from market growth. At the same time, you can manage your income streams according to your changing financial circumstances and goals. 

RIFs consist of conservative mutual funds with fixed-income securities and equities. They aim for steady returns with regular payouts but do not guarantee returns due to market risks. 

The Bottom Line

• Ideal For: Investors seeking flexibility and control over their investments
• Pros: Offer more flexibility than annuities
• Cons: Do not offer payment guarantees you get with annuities

Dividend-Paying Stock Funds vs. Fixed Annuities

Dividend-paying stock funds offer higher returns and regular income through dividends. They allow you to adjust your portfolio and liquidity while providing a reliable form of passive income. 

However, their income is not guaranteed, and they risk losing money due to market fluctuations.

The Bottom Line

• Ideal For: Soon-to-be retirees looking for lower-risk investments
• Pros: Potentially higher returns than annuities
• Cons: No guaranteed income, risk of losing money

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When To Choose an Annuity Alternative

Annuities are a valuable tool for long-term financial planning. Still, certain aspects of annuities may not align with your financial objectives, risk tolerance, or liquidity requirements. Additionally, some people worry about annuities’ complexity, fees, commissions, and taxation rules.

Annuities are insurance products. “Like any other insurance policy that consumers own, it’s important for everyone to have enough insurance — but not too much,” Moshe A. Milevsky, a professor of finance at York University and managing director of the private consulting firm PiLECo, told Annuity.org.

You might not need an annuity if you already have many other forms of guaranteed income, like a large pension from work or ample income from Social Security, according to Milevsky.

An annuity might not work for you if:

You need to access funds for large or emergency expenses quickly. 

Annuities are long-term contracts with potential penalties for early withdrawal or excess payments. It can be expensive to withdraw money for an emergency.

You prefer a more aggressive investment strategy with higher return potential.

Annuities shift market risk to the insurance company and offer stable returns. However, they may not be suitable for young investors with a higher risk tolerance.

You are confident that your existing funds will cover all your income needs in retirement.

Evaluate if you need an annuity based on your current income and expenses. According to AARP, consider how much you will spend, how long you will live, how much you will earn on your savings and how much you can withdraw from savings annually.

In these cases, an annuity alternative can be a better choice.

Case Study: Exploring the Alternatives to Annuities

Chuck Burton, a retired tax professional and annuity owner recently shared his experience with annuities in Annuity.org’s Personal Takes on Personal Finance. He mentioned the advice he passed on to his daughter when she was considering an annuity.

“You gotta look at what is your objective? What are you trying to do? I mean, are you trying to build up money? Are you trying to be safe? There’s a lot of factors,” Burton told Annuity.org. “So with the interest rates being so high, I say for the moment, since she’s pretty risk-averse, I would put it in probably, for the moment, a money market account.”

Though money market accounts offer lower interest rates than CDs, they are more liquid, allowing even easier access to her money.

The following case study is based on the real-world example given by Burton. It is a hypothetical scenario not intended as financial advice.

Client Profile: Barbara, a woman in her early 30s, recently inherited a substantial sum and is contemplating long-term investment for her retirement.

Background: Barbara, faced with various investment options and high interest rates amid 2023’s inflation, considered annuities for their stable income. She aimed to balance growth and security.

Objective: Barbara wanted to direct the windfall into her retirement nest-egg.

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Key Considerations:

1. Long Growth Horizon: Barbara’s youth provides a lengthy investment period, favoring higher risk-reward options for potential growth.
2. Interest Rate Environment: Annuities with stable returns are appealing, but they may not provide as competitive a total return as stocks and bonds.
3. Risk Aversion: Barbara’s cautious approach favors safety, but annuities’ limited growth potential exposes her to the opportunity cost of not accumulating as much wealth as she could via stocks..
4. Potential for Financial Emergencies: To address unforeseen problems, some of the money should be carved out and maintained within a stable-value and highly liquid vehicle.

Recommendation: Given high interest rates and Barbara’s risk aversion, a short-term CD placement seems prudent. CDs offer competitive rates and can be laddered for quick access, providing stability and liquidity. This will give Barbara immediate peace-of-mind, strong near-term income-generating potential and the time to explore higher-returning long-term investments better suited for retirement portfolios

Conclusion: Despite attractive annuity rates, Barbara’s financial goals and risk tolerance didn’t align, making a short-term CD a more suitable choice in the near term.

As with any financial planning strategy, consider all options before making final decisions about the right savings strategy. 

Most financial planning exercises do not entail “all-or-nothing decisions,” Milevsky said. “You don’t have to go ‘all in’ and can diversify across various products — some annuity, some not.”