How Fixed Annuities Can Stretch Your Retirement Savings

(Forbes) -- Managing investments and assets in retirement is a daunting challenge.

It is difficult to assess market performance over the long term, and in retirement, the time horizon is shorter than during accumulation years, further magnifying risk.

While working, you can offset losses with fresh capital from wages and employer matching. In retirement — a time when you want to be spending down savings — dry powder is harder to come by.

The result: Retirees are caught between the fear of depleting their nest egg too early and the fear of outliving it.

As with every phase of the investor lifecycle, diversity is an essential element to managing risk and helping protect against market volatility.

A fixed income annuity can mitigate the inherent uncertainty in retirement planning by providing a steady, guaranteed income stream, no matter where the market goes in your golden years and how long they last.

According to a McKinsey analysis, annuities are growing in popularity, both in absolute dollar terms and as a percentage of the overall life insurance business.

For the five-year period that ended in 2017, annuities accounted for almost $115 billion of all life insurance business in the Americas, up from nearly $60 billion in the five-year period that ended in 2007.

How They Work

In exchange for premium payments, which could be spread out over a period of months or years, or paid in a single lump sum, retirees receive a guaranteed predictable payment, typically on a monthly basis. In simplest terms, the fixed income annuity closely resembles a salary but paid out by a financial institution rather than an employer. It’s the financial institution’s responsibility to manage investments behind the scenes to come up with that payment — all the recipient has to do is spend the income.

So the benefits against volatility and in favor of peace of mind are clear. Instead of relying on the market to reward your investment intuition in a defined contribution plan like an IRA or 401(k), the annuity issuer pays a fixed amount that feels much like receiving a paycheck.

And even if you outlive your life expectancy, you’ll continue receiving a regular income. Annuities come in a variety of configurations. Here’s a quick look at some standouts:

Single-premium immediate annuities: This is the easiest type of annuity to explain. In exchange for a single lump sum paid by the buyer, the annuity starts paying benefits that very month.

Fixed indexed annuities: A fixed indexed annuity link returns to both a minimum guaranteed interest rate and a broad stock market index such as the S&P 500 or equivalent. So when that index performs well, holders earn more interest. But when the index dips, interest can’t contract below the guaranteed rate. This lets investors seek higher returns on an annuity purchase without downside volatility.

Deferred annuities: Also known as longevity annuities, this structure typically does not pay benefits until several years after premiums are paid in full.

The advantage to the buyer is a lower premium cost than an immediate annuity with the same benefit. The advantage to insurers is the ability to spread risk across a longer time horizon before paying monthly benefits to a policyholder.

The Biggest Planning Obstacle: Time 

Fixed income annuities reduce uncertainty both by protecting recipients from market fluctuations and by guaranteeing a steady stream of payments until death. Instead of trying to predict the appropriate amount of principal to withdraw in a given year, they provide income for however long your retirement lasts.

It’s in these advanced years when many starts to question whether their retirement asset mix and spend-down are appropriate and whether they will be adequately rewarded for taking a chance in the market. “Volatility isn’t always bad. What’s worse is when you’re not being compensated for riskier investments,” says Ben Harris, executive director of the Kellogg Public-Private Initiative.

 “But there is also a risk in being 95 years old, having no assets and not being able to go back to work.”

For that reason, Harris favors longevity annuities. “Longevity annuities allow you to address the potential risk of living into your eighties and nineties and running out of assets,” he says. “They allow people to take an impossible planning situation and turn it into a reasonable planning situation.”

A study by the Employee Benefit Research Institute found that, on average, committing up to 20 percent of a 401(k) balance to a 20-year deferred income annuity at age 65 improves retirement asset outcomes. 

Higher-wage earners do better with higher percentages committed to the annuity, at levels up to 30 percent of the 401(k) balance, because Social Security is relatively more generous for lower-wage earners.

Don’t Forget To Spend Your Money  

Fixed income annuities can also help retirement investors fight a less obvious risk: that of not spending enough in retirement. Suzanne Shu, associate professor of marketing at the UCLA Anderson School of Management, who studies behavioral economics with regard to retirement spending and annuity purchases, observes that some of the biggest mistakes made in retirement revolve not around running out of assets but around unintentionally spending too little.

In essence, each monthly decision to draw down more retirement assets or stand pat is a struggle, and the paralyzing twin fears of volatility and longevity win too many of those fights.

“Some retirees are afraid to spend down their nest egg and don’t know what to do,” she says.

Committing to the purchase of a fixed income annuity can provide a psychological green light to spend without fear of prematurely running out of assets. “Handing over the [premium] to buy the annuity is a big decision. But once made, a lot of your fears and concerns get resolved because you’ve got guaranteed income every month,” Shu says.

Purchasing a fixed income annuity is a complicated decision and investors will have different priorities and objectives surrounding their in-retirement spending and benefits for surviving spouses or other beneficiaries.

For those reasons, few investors commit all of their savings to these products. But they can help smooth out a lot of rough edges at a time when many would rather be able to focus on comfort, convenience, and certainty. And they insulate both everyday purchases and splurges in retirement from the daily gyrations of an ever-unpredictable market.


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