- When does purchasing an annuity make sense? Annuities add significant value to a retirement portfolio by providing safe growth during market downturns. One of the quickest ways to deplete your portfolio after retirement is by making withdrawals when the market is down. While a market downturn is beneficial for younger investors—offering opportunities to buy stocks at a discount—it can be detrimental during retirement. In retirement, any losses require higher returns just to break even. For instance, if you have $100,000 and lose 10%, you’re left with $90,000. A 10% gain on that $90,000 only brings you back to $99,000, meaning you would need an 11% gain to fully recover.
Drawing income from your accounts during a downturn compounds this issue, making it harder to recover. Fixed annuities can help protect against this by offering a safe place to draw funds during market volatility, safeguarding you from a negative sequence of returns. Traditionally, bond funds were used to balance portfolios and hedge against market volatility. However, given today’s interest rates and the increased volatility in bond markets, annuities have become a more reliable and sustainable alternative. Fixed or Fixed Indexed Annuities (FIA) often perform similarly to or better than bond funds, without the risk of loss. This allows you to let some of your investments grow in the stock market while using annuities for safety during turbulent times.
- When is an annuity not the right investment? Annuities should not be viewed as a replacement for stock market investments; rather, they are a safer alternative to bonds or CDs. They are conservative growth vehicles, meaning they generally won’t yield the same returns as a well-performing index fund like the S&P 500. Variable annuities, in particular, are often not a great alternative to other market investments due to lower performance, higher fees, and vulnerability to market losses.
Annuities also shouldn’t make up the entirety of your portfolio. Be cautious of anyone who suggest putting most of your money into an annuity. Annuities typically limit how much you can withdraw each year during the surrender period, which can last anywhere from 3 to 15 years. You want enough in an annuity to cover expenses during market downturns but not so much that you face penalties or fees in a financial emergency.
Annuities are generally not ideal for younger investors unless they have a low risk tolerance and are willing to sacrifice some gains for the security they provide during periods of market volatility.
- How do you choose the right deferred annuity? Start by researching the financial stability of the insurance company offering the annuity. AM Best is a great resource for checking company ratings. Next, identify your goals. Are you more concerned with income or growth? This will help you decide if you need an income rider or an annuity with higher growth potential. It’s important to choose a company with a history of providing consistent renewal rates. Keep in mind that annuities are contracts, and leaving them early can result in fees. The initial rates offered are not guaranteed throughout the life of the contract, so do your research and compare your options carefully.
- Anything else you’d like to add? Like any other investment tool, annuities should not be your sole strategy. When used properly, they can be highly effective. Unfortunately, there is a lot of misinformation about what annuities are good for and what they aren’t. The wide variety of annuities can also add to the confusion. Since annuities can be complex, it’s important to spend time educating yourself on how they work. Take time to understand the different types and their components. Some of my clients have started with a small annuity just to see how it works. After gaining experience, they felt more confident in how to incorporate annuities into their broader portfolios.