Annuities as a Retirement Savings Option

A retirement annuity provides a regular income stream during retirement. Individuals pay insurance companies a premium in return for their funds growing at a variable or fixed rate. As pension plans become less common, retirement annuities gain popularity as a retirement savings option.

Retirement annuities come in three main types: fixed, variable, and indexed. Fixed annuities provide a guaranteed return over a specified period, with individuals able to know how much to expect when the payout begins. Variable annuities offer growth potential but come with more risk, with the payout depending on an investment and market performance. On the other hand, a fixed indexed annuity provides both growth potential and safety and access to yearly withdrawals.

There are two payout options for retirement annuities: immediate or deferred. Immediate annuities require an upfront, one-time premium and start paying out in monthly installments soon after. They are best suited for individuals close to retirement seeking steady regular payments. Conversely, deferred annuities require individuals to pay premiums over several years. The payouts begin after retirement, making it suitable for those who want to save over time and with long-term perspectives.

With regular payments (monthly, quarterly, or yearly), individuals can take care of their daily needs, pay their medical bills, and save money for emergencies. A consistent income stream throughout retirement also provides financial independence, which means less reliance on others for financial support and the ability to maintain one’s lifestyle and pursue goals.

Additionally, retirement annuities allow for tax-deferred growth, meaning the gains on the premium can grow without incurring taxes until withdrawal, i.e., if the annuity is non-qualified (not set up with a tax-advantaged account like an IRA or 401(k)). Annuities also provide a death benefit through insurance in case of the annuitant’s passing before withdrawals begin; the insurance pays out this money directly to the beneficiaries, avoiding the need for them to go through probate court.

Unlike other investment alternatives like certificates of deposits (CDs), bonds, and life insurance, annuities have an edge. For instance, CDs offer a set rate of return over a specific period and are guaranteed by banks, while annuities have more customization options and are provided by insurance companies.

Bonds have a set maturity date with unchanging terms, while annuities have tax-deferred growth and may have higher yields depending on the period. Moreover, Annuities provide a lifelong income stream until death and have tax-deferred growth, whereas life insurance only pays out a death benefit to loved ones.

Annuities can also come with a few drawbacks, such as high fees, individuals not being able to withdraw their money until a particular time, and the potential of losing control over one’s investment. Therefore, it may not be suitable for individuals with enough savings and social security benefits or those with a shorter life expectancy who may not live long to enjoy the benefits.

How would an annuity fit into an individual’s retirement plan? An individual may combine annuities with other retirement savings and investment vehicles such as 401(k) plans, IRAs, and life insurance to establish a comprehensive and diversified plan. However, individuals should know that although annuities have no contribution limits, unlike IRAs and 401(k)s, allowing for more savings, if combined with these investment vehicles, there may be limits on contributions.

“Investment advisory services are offered through Fusion Capital Management, an SEC- registered investment advisor. The firm only transacts business in states where it is properly registered or is excluded or exempted from registration requirements. SEC registration is not an endorsement of the firm by the commission and does not mean that the advisor has attained a specific level of skill or ability. All investment strategies have the potential for profit or loss.”

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Inflation and Its Impact on Retirement

Inflation is the average change in the price a consumer pays for a basket of goods and services over time. As inflation increases, the currency unit holds less purchasing power over goods and services than it could in the past.

The three leading causes of inflation are demand-pull, cost-push, and built-in. Demand-pull happens when demand for goods and services exceeds supply, raising prices. Cost-push is caused by rising production costs, which manufacturers pass on to consumers at higher prices. On the other hand, built-in inflation is when businesses raise prices in anticipation of future inflation.

Although inflation affects everyone, retirees are especially vulnerable since their income sources may not be adjusted to keep up with rising prices. Inflation may negatively impact a retiree’s pension benefits. If high inflation occurs during the last years of a retiree’s career, their benefits may be based on pre-inflation salary figures and thus be lower than expected. These pension benefits, not adjusted for inflation, may result in a decline in purchasing power over time.

Investment accounts, such as 401k and IRA, may also suffer from inflation. As inflation increases, the value of investments in these accounts may decrease, resulting in lower returns. Companies may also suffer because if the government raises interest rates to combat inflation, the increase can negatively impact 401(k)s by decreasing bond prices, making it harder for them to raise debt. However, sometimes certain assets, such as commodity prices and government bonds, may rise with inflation.

Inflation can also reduce investment growth, causing challenges for retirees to meet their income needs. This difficulty in meeting needs may force retirees to use savings to pay for basic needs, which makes it harder to maintain their living standards. Additionally, inflation may alter retirees’ expenditures and force them to spend only on necessary goods and services. Controlling finances and saving where possible is also vital in times of high inflation.

One way to combat inflation about one’s retirement is to avoid relying on past occurrences that can be misleading and lead to overcompensation for perceived inflation risk. Individuals should avoid aggressive investments that may leave them vulnerable to market downturns. Instead, they should plan and calculate their retirement needs early, factoring in inflation to determine when to retire and what lifestyle they can afford with rising prices.

Individuals may also cope with inflation during retirement by being flexible and making adjustments, such as moving to a more affordable area, cutting back on travel expenses, or finding ways to reduce spending in locations impacted most by inflation. Additionally, taking advantage of Social Security benefits can provide a stable source of income that increases the cost of living.

Retirees should also diversify their income streams to ensure a stable financial future. While some income sources may increase due to inflation, others may remain stagnant; consequently, retirees should seek out income sources linked to cost of living adjustments. Moreover, they should take some risk and continue to invest money even after retirement in places like the stock market, which has historically had a reputation for outpacing inflation.

“Investment advisory services are offered through Fusion Capital Management, an SEC-registered investment advisor. The firm only transacts business in states where it is properly registered or is excluded or exempted from registration requirements. SEC registration is not an endorsement of the firm by the commission and does not mean that the advisor has attained a specific level of skill or ability. All investment strategies have the potential for profit or loss.”

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The Case for Diversification in Investing

 Diversification is a widely prescribed investment strategy, and for good reason. It is essential for lowering inherent risk in a portfolio while optimizing long-term returns.

There are a number of asset classes an investor can include in their portfolio to achieve diversification. They include stocks, bonds, annuities, and alternative investments like real estate. However, diversification doesn’t just mean investing in several asset classes, it means investing in assets that move differently from each other.

In his landmark research in the 1950s, Harry Markowitz established that the risk level of a portfolio is not just in the sum of its components, but also their correlations. Do their prices go up and down together or do they move independently of each other? By building a portfolio of assets that have low correlations, an investor will achieve better risk-adjusted returns long term.

Consider research by Vanguard on the success of various stock versus bond portfolios between 1926 and 2018. Stocks and bonds have low correlation, so what are the benefits of investing in each individually versus combining the two? Starting with stocks, researchers found that over the 93-year period, a portfolio that was 100 percent stocks earned an average annual return of 10.1 percent. However, it suffered losses in 26 out of the 93 years, with its worst loss being a 43.1 percent dip.

What about a portfolio that was 100 percent bonds? In that 93-year period, this portfolio earned an average annual return of 5.3 percent but only had 14 loss years, the worst of which was a mere 8.1 percent.

Both examples feature portfolios that were not diversified by asset type. From their returns, it is evident that stocks alone had a higher return but at a much higher risk of loss, while bonds alone had a lower return but a lower risk of loss. By blending both asset types in a portfolio, an investor can achieve both good returns and low risk levels. That is the essence of diversification.

To show this practically, the researchers at Vanguard put together a portfolio that was 60 percent stocks and 40 percent bonds. They found that this portfolio achieved an 8.6 percent average annual return and had only had 22 down years, the worst of which was 26.6 percent. Overall, that’s a much better risk-adjusted return.

While the example above focused on stocks and bonds, investors today have many more options with regard to the asset classes they can include in their portfolios. In each asset class they allocate to, investors should also apply the principles of diversification. For example, if they allocate 20 percent of their funds to stocks, they can buy different types of stocks. They can mix large-cap stocks with mid- and low-cap stocks or buy stocks of companies in different industries. They can even diversify geographically, buying stocks of companies in different countries.

Similarly, there are different types of bonds and annuities. With bonds, there are short- and long-term Treasuries as well as federal, state, municipal, and corporate bonds. For annuities, there are fixed and variable annuities, among other classifications. There are also alternative investments like real estate, precious metals, private equity, and cryptocurrencies. Investors who want to diversify their portfolios should talk to a financial advisor to guide them on the mix that is most appropriate for them, given their current position, goals, and risk tolerance.