Fixed Annuities in Volatile Markets: A Smart Retirement Income Strategy

Investopedia says the S&P 500 Index (a common indicator of broader market performance) has provided an annual return of more than 10% since 1957. However, this does not mean you should count on receiving a 10% return each year for your stock market investments. Some years are better than others. During market downturns, investors may even see significant losses in their investment portfolios.

Why Retirees Tend to Prefer Safe Investment Options

Short-term market volatility may not be a problem for young workers who have plenty of time to ride out market downturns and stock market crashes – they can simply wait for stock values to rise again. In their case, the risk of short-term losses is worth the reward of higher long-term gains.

For retirees and people near retirement age, it’s a different story. If your retirement savings is invested in stocks and the stock market crashes, you may lose a large portion of your nest egg. If you’re depending on that money to cover your near-term expenses, you may face major financial hardship. You might even have to delay your retirement or return to work just to make ends meet.

For this reason, many people begin to move their funds from higher- to lower-volatility options as they near retirement. A fixed annuity is one option for people who are looking for a less volatile way to fund their retirement.

How Fixed Annuities Protect Against Volatility

Understanding how fixed annuities work is key to understanding why they protect against the risk inherent in other options for retirement savings.

An annuity is a contract between a policyowner and an insurance company. The policyowner purchases the annuity by paying the insurance company an upfront premium. In exchange, the insurer provides payouts. Through this arrangement, an annuity provides a guaranteed source of retirement income. Many retirees turn to annuities because they are worried about running out of money and want a guaranteed income solution that will provide lifetime payouts.

However, not all annuities provide a safe haven from volatility. The two most common types are variable annuities and fixed annuities:

1. Variable annuities have variable growth and payouts. The annuity grows at a variable crediting rate tied to the performance of the underlying investments. This growth determines the size of future payouts. If the underlying investments perform well, the growth is higher and the payouts are larger. If the underlying investment performs poorly, the growth is lower and the payouts are smaller. This means variable annuities are vulnerable to volatility.
2. Fixed annuities provide fixed growth and set payouts. When the policyowner purchases the annuity, the contract establishes a fixed minimum crediting rate. This means that you are shielded from losses. In some cases, your fixed annuity will have a crediting rate that’s more than the minimum that is guaranteed for a certain period of time (MYGA). In other cases, your annuity’s growth may be tied to the growth in an external index (FIA). But in both cases, as long as you don’t take early withdrawals or cancel the annuity, you will not lose any of the money that you put in the annuity, no matter how the market or other investments perform. This means fixed annuities are not vulnerable to losses from volatility.

There are also variations on these two main types. For example, a fixed indexed annuity is a compromise between a fixed and a variable annuity. Fixed indexed annuities are tied to an index, such as the S&P 500. The growth and payments depend on the performance of this index, but the annuity also has a minimum return rate that is guaranteed regardless of market performance. This means fixed indexed annuities are vulnerable to market volatility, but the impact is controlled.

Determine Your Risk Appetite: Fixed Annuities vs. Stocks

If you’re trying to secure your retirement, you might be interested in a safe financial strategy. However, no strategy is completely foolproof. Keeping your money in a bank account is the safest option, but there’s still a chance the bank could fail or skyrocketing inflation could cause your money to lose value.

Nevertheless, some financial strategies are riskier than others. In the short term, investing in the stock market may be risky due to the possibility of a market downturn or even a stock market crash. Other assets (such as cryptocurrencies) may be even riskier due to extreme price volatility.

You may be wondering why some people choose to invest in these assets if they are risky. The answer lies in the principle of risk versus reward. In general, higher-risk options tend to come with the possibility of larger rewards, while lower-risk options tend to provide smaller rewards. Gambling is the ultimate high-risk, high-reward option: when you gamble, there is an extreme risk that you will lose all your money, but, if you are lucky and win, the reward may be significant.

Most people don’t want to gamble with their retirement. That’s why lower-risk options tend to be popular, such as fixed annuities in volatile markets.

To select a retirement option that’s right for you, consider your personal risk appetite. If you have a high-risk appetite, you may be comfortable with an option that has more exposure to market volatility in exchange for the chance of a bigger reward. If you have a low-risk appetite, you may be more comfortable with an option that provides a guaranteed return rate.

Choosing an Annuity Based on Your Risk Appetite

If you’re looking for a safe haven from the market’s ups and downs, it’s important to select the right type of annuity for your goals.

• Variable annuities are vulnerable to market volatility – you could lose money due to market risk.
• Fixed indexed annuities are somewhat vulnerable to market volatility – your growth rate could be lower due to market volatility.
• Fixed annuities are safe from market volatility – you know exactly what your growth rate will be.

Beyond Market Volatility: Choosing the Right Annuity

Volatility is a critical issue to consider when selecting a retirement planning strategy, but it is not the only thing that matters. You should also think about the impact of fees and taxes.

• Excessive fees may take a sizable chunk of your funds. In general, variable annuities tend to have higher fees than fixed annuities, but there are variations between companies. Make sure you understand the fees that may apply before you buy an annuity.
• High tax rates and unexpected tax bills may become a burden for retirees and people who are saving for retirement. Annuities provide tax-deferred growth, meaning you don’t have to pay taxes until you withdraw money or receive a payment, which is an advantage of annuities. In some cases, your state may impose a premium tax on annuities. If that is the case, the tax is generally deducted from your initial premium by the insurance company and passed along to the state.

Is an annuity right for you? If you’re looking for guaranteed retirement income, it might be! Canvas provides fixed annuity options designed to reduce the impact of market volatility during retirement. Use the calculator to see how much you could earn with a Canvas annuity.