Key Takeaways
- Immediate annuities and coupon bonds both work by turning a single lump sum into a stream of payments.
- Both products carry very little risk and generate predictable returns, with a guaranteed rate and payment terms.
- However, immediate annuities are more customizable and offer tax advantages, while coupon bonds are more liquid.
How Immediate Annuities and Coupon Bonds Are Alike
Immediate annuities, also known as single-premium immediate annuities (SPIAs), share many similarities with coupon bonds. Both products can generate reliable income for many years, making them popular options for retiree investors.
To acquire a SPIA or coupon bond, you make a single lump-sum payment to an issuer. In return, the issuer promises to pay income for a set period. For annuities, that issuer is usually an insurance company. For bonds, it’s either the federal, state or local government, or a corporation.
Both immediate annuities and bonds establish specific payment dates from the start. With both, you’ll know exactly when your payments will begin and how much they’ll be. You and the issuer agree upfront on stated payment dates and the rate for payments.
SPIAs and coupon bonds are considered some of the safest investment vehicles available, because the issuer guarantees the payments. With both products, the main risk to be aware of is credit risk: that is, the risk that the issuer’s creditworthiness will decline and it will not be able to fulfill its obligations.
Bonds and annuities are staples of retirement income plans but differ in important ways. Both can be used as complementary strategies within retirement when structured correctly. Annuities can offer stable lifetime income but little to no liquidity. Bonds, on the other hand, offer greater liquidity as they mature but display reinvestment risk. There is no way to predict whether you will be able to reinvest your bond principal at the same interest rate after it matures.
Stephen Kates, CFP®Principal Financial Analyst for Annuity.orgStephen Kates, CFP® is a personal finance expert specializing in financial planning and education. He serves as the Principal Financial Analyst for Annuity.org, where he delves into industry trends to support consumers and financial advisors on wealth management, annuities, retirement planning, and investing.
Differences Between Immediate Annuities and Coupon Bonds
While SPIAs and coupon bonds share many characteristics, these two products can serve very different purposes in your financial plan. A significant difference between an immediate annuity and a coupon bond is the relationship between the issuer and the purchaser.
When you purchase a SPIA, you enter a contractual agreement as the owner of the annuity, and potentially also the annuitant. The annuity provider is the issuer in the contract, and you must also name a beneficiary to receive the annuity’s death benefit.
In a coupon bond contract, the bond purchaser takes on the role of lender. You are essentially lending a lump sum of money to the issuer – be it the government or a corporation – and agreeing to receive interest payments at regular intervals until the bond matures, at which time you get back your initial investment.
SPIAs Are Designed for Lifetime Income
Another key difference between immediate annuities and coupon bonds is how long the income from each product can last. Coupon bonds have a maturity date, after which the face value of the bond is paid in full. The maturity term of a coupon bond can range from one year to 10 years or more.
Immediate annuities can pay out in a few different ways. You can choose a period certain payout, which guarantees payments over a certain number of years, similar to a coupon bond.
However, most people who purchase SPIAs opt for the lifetime payout. With this, you can turn the lump sum premium into a stream of income you cannot outlive.
Nearly 30% of Americans age 45 and up are concerned about outliving their savings in retirement, according to a recent Annuity.org survey. SPIAs help address this risk by guaranteeing income for life.
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SPIAs Are Customizable
Besides choosing how long payments last, owners can customize their immediate annuity in a variety of ways. Many annuity providers allow SPIA owners to choose how frequently they receive payments: monthly, quarterly, semiannually or annually.
SPIA owners can add on riders for an additional cost that further modify the contract terms. Riders might add on a cost-of-living increase to help payments keep pace with inflation, a cash-value death benefit for the contract’s beneficiaries, or other features.
Unlike with SPIAs, you can’t modify or negotiate coupon bond contracts. You might shop around and choose a contract that has more attractive terms, but once you pick one, you can’t change those terms.
Coupon Bonds Are More Liquid
It’s possible to buy and sell coupon bonds in a single day, making them far more liquid than immediate annuities. Annuity providers usually do not allow SPIA owners to cancel their contract or take withdrawals without incurring penalties.
SPIA Payments Are Partially Taxable
An important consideration when purchasing a SPIA or coupon bonds is the taxation of your payments. The payments a coupon bond makes are 100% taxable, as they are fully composed of the bond’s interest earned.
Immediate annuity payments are different. Each payment has a portion of the original premium and a portion of the interest earned on the contract. This means only the interest portion of SPIA income is taxable.
Which Is Right for You?
Both immediate annuities and coupon bonds can serve a purpose in your financial plan, generating reliable income with principal protection. However, one product might better suit your unique financial needs and goals.
To determine whether an immediate annuity or coupon bonds are right for you, consider your priorities. If lifetime income is most important to you, or if you want the opportunity to customize your contract, you might choose an immediate annuity. However, if you only want to generate income for a few years and don’t want your money tied up for long periods of time, coupon bonds might be a better choice.
As always, when deciding to invest your savings in bonds, annuities or other financial products, you should consider seeking expert assistance. A licensed financial professional can offer advice based on your specific circumstances.
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