Using Annuities to Mitigate Retirement Risks

At Prime Capital Investment Advisors, we are constantly looking for new ways to achieve unique goals for our clients based on their ideal lifestyle. For some, that can mean a traditional mix of stocks and bonds that have the potential to achieve both growth and stability. For others, it can mean incorporating non-traditional asset classes that have different features. One of those options is an annuity.

While annuities have always played some role in retirement planning, growing uncertainty and market volatility have caused their importance to boom. For those whose goals align with the features of an annuity, these insurance products offer the chance for growth along with the protection of principal during market downturns which is guaranteed by the claims-paying ability of the issuing insurance carrier.

While they can be a vital part of the retirement-planning process, annuities can sometimes be overlooked by advisors who focus strictly on accumulation and stock market investments. But the truth is, investors do not always have to sacrifice growth potential under an annuity contract, as some, like fixed indexed annuities, can allow annuitants to participate in stock market upside while still achieving principal protection. This means that annuities can be valuable for people getting close to retirement or for those without the appetite or flexibility for stock market risk.

In fact, annuities were created for retirement. They were first invented during ancient Roman times to compensate retired soldiers. Now, they’re meant to help pre-retirees and retirees generate income once they stop collecting wages. They are also different from retirement accounts like 401(k)s and IRAs in that they are not subject to market risk, and they offer guarantees based on the terms of an annuity contract and the claims-paying ability of the issuing carrier.

In other words, fixed and fixed indexed annuities can offer a guaranteed income stream to mitigate some of the uncertainty and risk that comes with retiring. It’s important to understand fixed and fixed indexed annuities are not investments, they are contracts. Even though they may credit interest based on market gains, they are not actually invested in the market at all. They can, however, offer varying rates of market participation, potentially allowing annuity holders to achieve market upside.

They can also defend against many retirement risks, such as longevity risk, or the risk of running out of money while still alive. Longevity risk is one of the chief concerns of Americans on their way into their golden years, as 56% are currently worried about their ability to fund a secure, desirable retirement ^[1]. That worry seems to be well-founded, as a 2019 study projected that over 40% of U.S. households will run out of money in retirement ^[2].

One of the biggest reasons retirees run out of money is sequence of returns risk. This can happen when clients withdraw money from accounts early in retirement in a down market. The withdrawals can then out-pace the growth of the account, making it more likely that a person completely drains their funds while still living.

A fixed indexed annuity can counter both longevity risk and sequence of returns risk by providing a guaranteed lifetime income option. Under a properly structured fixed indexed annuity, the principal and the lifetime income benefit are both protected, which can be beneficial in a market crash. They also offer flexibility in diversifying your portfolio income, as retirees with a guaranteed lifetime income benefit can keep other assets invested in the market, conceivably giving them a chance to wait out valleys and plateaus while still having a source of income that they know will be there no matter how long they live.

Another one of the biggest risks for retirees is inflation, which some annuities are even designed to help combat by offering a COLA, or a cost-of-living adjustment. Considering the 2021 and 2022 inflation rates were the highest America has seen in more than 40 years^[3], it’s no wonder experts are expecting an increase in inflation-protected annuities ^[4].

While annuities are popular among those looking for protection as well as growth potential and a diversified stream of income in retirement, purchasing one can be treacherous without proper help. There are many different types of annuities, and they won’t all offer identical benefits or protections. For example, variable annuities are directly invested in the market and carry the same risk that any market investment would.

There are pros and cons to each type, and innovative insurance companies are working to design new annuity products with enhanced benefits every single day. It’s crucial to find a product that aligns with your goals and your desired lifestyle as you work to fund your post-career dreams.