For investors concerned with outliving their income or being able to cover their retirement expenses, two investment options are garnering attention – one for its promise of guaranteed lifetime income and the other for the opportunity to earn higher interest with relatively low risk. Annuities are appealing to those who most fear outliving their income, while some types of fixed-income exchange-traded funds (ETFs) address concerns over covering retirement expenses. Which option is better depends on factors that include an individual's priorities, preferences and circumstances; there are risks and rewards for both.

When an Annuity Is Better

Although there are annuity variations that serve different purposes, annuities were originally created to provide a guaranteed income for life. This immediate annuity or income annuity is set up as a contract between an individual and a life insurance company that exchanges a lump sum of money for a promise of a monthly payout that the individual cannot outlive. An annuity is the only vehicle that can guarantee that an individual won't outlive his/her income.

Annuity Disadvantages

Although an annuity is considered a riskless investment, the guarantee of lifetime income is only as strong as the financial position of the life insurer. Life insurers that are assigned a financial strength rating of A or better by A.M. Best Company are considered to have an excellent ability to meet their ongoing obligations.

The larger risks with annuities have to do with their liquidity and their ability to maintain purchasing power. Once monthly payments commence, the lump sum investment is irrevocable. If the annuitant dies after receiving a few payments, the principal balance remains with the insurer. There are annuity arrangements in which a portion of the principal can be refunded to the beneficiaries, or the payments can be structured as joint life with survivorship. However, these arrangements reduce the monthly payment based on the additional risk the insurer assumes. Also, annuity payouts are fixed; over time, they may not keep pace with inflation. Some annuity contracts offer a cost-of-living rider that can offset the loss of purchasing power, but it reduces the initial monthly payment.

When Fixed-Income ETFs Are Better

As an alternative, retirees may want to consider ETFs that invest in preferred stocks, which can substantially increase yield without a significant increase in risk. Preferred stocks are a cross between common stock and a bond. Although the share price tends to move in concert with the company's common stock price, it is also heavily influenced by the direction of interest rates. Preferred stock dividends are taxed at a maximum rate of 20%, which makes their after-tax yield even more attractive. Preferred stocks are considered to be much safer than common stocks because their dividends carry a higher priority and must be paid out before common stock dividends.

The iShares U.S. Preferred Stock ETF (NYSEARCA: PFF) is the largest fund in its category, with nearly $17 billion in assets under management (AUM). As of July 20, 2016, its SEC yield was 5.62%. The fund's portfolio is broadly diversified, with no security weighted more than 2.45%. Most of its portfolio is invested in BBB- or B-rated securities. Its expense ratio is 0.47%.

Fixed-Income ETF Disadvantages

Fixed-income ETFs are sensitive to interest rates. Bond and preferred stock prices may decline as interest rates increase. Bonds and preferred stocks are also subject to credit risk and industry sector risk. A lower credit rating indicates an increased risk of insolvency. Some industries also have their own particular risks. Preferred stock ETFs tend to invest heavily in the financial industry because banks are prevalent issuers of preferred stocks.

A Blended Solution

It is never advisable to invest too large a portion of a retirement income portfolio in any single investment. Retirees concerned about outliving their income and being able to meet their retirement needs should consider a blended solution – investing a portion for high current yield, such as a preferred stock ETF, and investing a portion as longevity insurance with an annuity.

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