Expenses can climb with a laddered bond portfolio; annuities may be a better option

When creating a retirement income plan, the return that you get on your investments is just one small piece of the overall puzzle. That’s because you also want to make sure that you net out the highest possible amount of spendable cash flow – and one of the biggest hurdles to accomplishing this is the charges and fees that you incur on the income-generating financial vehicles.

While “safe” money investments like bonds have been a traditional go-to income generator for many retirees over time, the reality is that these instruments can both limit investment returns and increase default risk for investors. They can also be ripe with expenses – some that investors aren’t even aware of – that can drastically reduce the amount of net spendable income generated.

With that in mind, there may be some viable, and less expensive, alternatives to using the traditional bond laddering strategy for retirement income – and one of those options could be a fixed indexed annuity.

Are indexed annuity fees higher than expenses on a laddered bond portfolio?

So, which has higher fees, a fixed indexed annuity or a bond latter? In order to make that determination, it helps to have a good understanding of how each of these financial products and strategies work.

Fixed indexed annuities (FIAs)

Fixed indexed annuities, or FIAs, are a type of fixed annuity. The biggest difference between a fixed indexed annuity and a regular fixed annuity is the way that the return is determined. For example, fixed indexed annuities track one or more market indexes, such as the S&P 500.

When the index performs well, the annuity is credited with a positive return, typically up to a set maximum. In return for this “limited” growth, though, if the underlying index performs poorly – even to the tune of a negative 10% or 20% for a given contract year – no loss is incurred by the investor. Rather, the annuity is credited with a guaranteed minimum return (which is oftentimes in the range of 0% or 1%).

As with other types of annuities, the growth that takes place inside of the FIA account is tax-deferred until the time of withdrawal. This can allow the funds to grow exponentially – especially over a period of time.

If or when the time is right, a fixed indexed annuity can be “annuitized,” or converted to an income stream. There are usually several different options that may be chosen for taking income from an FIA, such as:

• Period certain – As its name implies, period certain represents a set period of time, such as 10 or 20 years. After the time period has elapsed, the income from the annuity will stop.
• Lifetime only – Lifetime only will provide income for the remainder of the annuitant’s (i.e., income recipient’s) life – regardless of how long that may be. Many annuities will also offer joint and survivor lifetime income where the funds continue to be paid out until the death of a second person, such as a spouse or partner.
• Life with period certain – Life with period certain “combines” the period certain and lifetime income options. That’s because income will be paid for the annuitant’s lifetime. However, if he or she passes away before a certain time has elapsed – such as 10 or 20 years – the income will continue being paid to a beneficiary for the remainder of that time frame.

Different types of annuities can charge different fees. In the case of the fixed indexed annuity, you could incur some or all of the following expenses:

• Mortality and expense (M&E) – M&E fees pay for the various insurance-related guarantees that are included in an annuity. These can also include the administrative expenses of the annuity contract. It is important to note, though, that these fees are already “embedded” in the stated rate or guaranteed income amount of the annuity. So, there is no added charge to the investor.
• Surrender charge – While many FIAs allow you to withdraw up to 10% of the contract value each year, penalty-free during the “surrender” period (which usually lasts for several years after purchasing the annuity), if you cancel the contract or take out more than the allowable amount, you could incur a surrender fee.
• Rider fee – If you decide to add an additional rider to the annuity, you may also be required to pay a higher amount of premium.

Given this, however, if a fixed indexed annuity buyer does not add any optional riders to the contract, and they keep their money in the contract for the long-term, they could theoretically not pay any added charges or fees at all.

Laddered bond portfolio

A laddered bond portfolio consists of multiple bonds that all mature in different years. For example, an investor may place an equal amount of money into five separate bonds, with one that matures in one year, another that matures in two years, and so on.

Fixed Index Annuities vs Laddered Bonds

	Fixed Index Annuities	Laddered Bond Portfolio
Up-front agent or broker commission charge	Fixed Index AnnuitiesNo	Laddered Bond PortfolioYes
Tax-deferred growth	Fixed Index AnnuitiesYes	Laddered Bond PortfolioNo
Guarantee lifetime income	Fixed Index AnnuitiesYes	Laddered Bond PortfolioNo
Income amount changes over time	Fixed Index AnnuitiesNo - unless an inflation rider is added	Laddered Bond PortfolioYes - depending on interest rates when the bonds are purchased, meaning future income could be higher or lower
Liquidity	Fixed Index AnnuitiesYes - although limited through the annuity's surrender period	Laddered Bond PortfolioYes - at the bond's maturity
Surrender charge or penalty if funds are accessed early	Fixed Index AnnuitiesYes	Laddered Bond PortfolioYes
Subject to interest rate risk	Fixed Index AnnuitiesNo	Laddered Bond PortfolioYes - so future income could be lower

Typically, the bonds that have the longest maturities will pay the highest rate of interest. With that in mind, as each of the bonds matures, the investor can use those funds to buy another 5-year bond instrument, until eventually he or she has a portfolio of bonds that all have a longer maturity (and higher interest rate), while still having a bond mature each year. (In the meantime, the investor can use the interest that is generated from these bonds as a source of retirement income).

Typically, the bonds that have the longest maturities will pay the highest rate of interest. With that in mind, as each of the bonds matures, the investor can use those funds to buy another 5-year bond instrument, until eventually he or she has a portfolio of bonds that all have a longer maturity (and higher interest rate), while still having a bond mature each year. (In the meantime, the investor can use the interest that is generated from these bonds as a source of retirement income).

While bond laddering can certainly offer some nice perks, these financial vehicles an also be somewhat expensive for investors and retirees to own. For example, Standard & Poor’s has estimated that the average markup is 0.85% of a bond’s par value with investment grade corporate bonds, and 1.21% for investment-grade municipal bonds. However, the actual markups can range from as little as 0.1% to as high as 5%, or from $1 to $50 on the purchase of a $1,000 bond.

Are there any other pros and cons when considering FIAs and a laddered bond portfolio?

There can actually be a number of potential advantages and drawbacks to keep in mind when considering a fixed indexed annuity and/or a laddered bond portfolio. For instance, according to economist and Retirement Income Certified Professional, Wade Pfau, in a low interest rate environment – which the U.S. has been squarely in the midst of since the 2008 recession – the case for an annuity (versus a bond ladder) could be quite strong, because the annuity’s mortality credits are not impacted by rates.

Mortality credits are created when some people die sooner than expected and do not receive as many annuity income payments from an insurance company as others who live longer and receive more income payments.

Alliance America can help

Alliance America is an insurance and financial services company. Our financial planners and retirement income certified professionals can assist you in maximizing your retirement resources and help you to achieve your future goals. We have access to an array of products and services, all focused on helping you enjoy the retirement lifestyle you want and deserve. You can request a no-cost, no-obligation consultation by calling (833) 219-6884 today.