Annuities can provide a stream of income for individuals in retirement, and can be a useful financial option to allow savings to last, in some cases, for the rest of the individual’s life.
Unlike investments tied to markets, annuities are contracts based on the assets of insurance companies, which are typically much more stable and predictable. They can play an important role by converting a portion of accumulated assets into a predictable source of income. Certain annuities can provide guarantees that other investments can’t. And that can be reassuring while offering security that lets retirees enjoy their time.
The key reason to consider annuities is the potential for protected income. As a person retires, the financial challenge shifts from accumulating as much wealth as possible to protecting assets while managing taxes, inflation, longevity, and market volatility. An annuity can help address this transition by creating an income stream that is less dependent on the day-to-day performance of the stock market.
This can be especially valuable in dealing with ongoing expenses such as housing, food, utilities, and healthcare, which are easier to manage if income streams are predictable. And this can free up other assets to remain invested elsewhere.
A challenge for any retirement plan is sequential risk, also known as sequence-of-returns risk. Sequential risk considers the timing of how investment events occur, and how they may negatively affect a retiree’s portfolio, particularly when withdrawals begin.
Look at this example: Two retirees who have the same average investment return over a 20-year period, yet one retiree experienced significant market losses early in retirement. This weakens the portfolio early, and can have an impact on income for the rest of the person’s life.
Withdrawals taken from a declining portfolio compound the effect of early losses, reducing the chances of recovery when markets improve.
So protected income is especially valuable during the early years of retirement. If a retiree can cover some essential expenses through guaranteed income, there may be less pressure to sell investments during a market downturn.
An annuity can therefore serve as one potential tool to guard against sequential risk through income not directly tied to volatile market conditions.
Like any investment, annuities have some element of risk, and different types can provide different benefits. You can consider annuities as a useful component of a broader retirement-income strategy, and the fact that they can provide protected income can be very reassuring, especially in early retirement.
Determining how much of a portfolio should be allocated toward protected income involves a number of factors: individual goals, risk tolerance, other sources of guaranteed income, liquidity needs (immediate and future, since annuities are longer term investments), and overall financial situation.
There are several types of annuities, and they serve different purposes. Some are designed to provide:
