From Forbes-- Whether you are retiring with $100K, $1 million, or $10 million, you likely have the same question: How can I help protect and preserve my principal, so I don’t have to worry about my money in retirement?
It only makes sense that this is such a common question when talking about retirement; during your 30+ years of working and investing, you continually invested during good market cycles as well as bad market cycles.
When you shift your accounts from the accumulation stage to the distribution phase, the rules change quite a bit.
No longer are you able to stomach a 20%, 30%, or 40% loss in your accounts.
Most people I speak with don’t want all of their money exposed to market risk due to fear of the unknown. The S&P 500 has been on a very good run the last handful of years, but what happens if we have another 2008?
In 2008, the S&P 500 lost 37%.(1) If you retired in 2007 and were heavily invested in this index, I highly doubt you were sleeping well at night. You were probably anxious, nervous, and maybe even making yourself sick over what was happening to your life’s savings.
So, what alternative is available that is designed to give you a greater potential for growth but also limits or eliminates market risk?
A fixed index annuity is a contract issued by an insurance company that provides the opportunity to earn interest based on positive returns in an index, such as the S&P 500. If the index experiences negative returns, an index annuity contract is not impacted.
Let’s look at a simple example of an account that participates in the S&P 500 at 50%. Every policy anniversary, you lock in interest credits for that year. If the S&P 500 is up 26%, you receive 13%. If the S&P 500 is up 8%, you get 4%. If the S&P 500 is down 20%, you get 0%.
There’s a cheesy saying we use in this scenario: “Zero is my hero.” My clients understand that the year they receive 0% is the year their next-door neighbor likely lost money. The key thing to realize is that you never have to play catch-up to the previous year’s losses.
Aside from the safe growth and accumulation piece of a fixed index annuity, income riders can also be added to (or left off) an account.
This rider is designed to pay either single or joint lifetime income, regardless of the funds available in the account, which can be quite helpful for a person who is retiring and seeking additional income over and above their Social Security, pensions, and other income sources.
Some carriers also offer long-term care coverage on an account.
This type of benefit can be a smart move for someone who doesn’t want to pay for a stand-alone LTC policy but also realizes that they should have some type of benefit available if they do require LTC services in the future.
Just like any other investment or insurance product, a fixed index annuity has weaknesses. Most accounts only allow you to access 7-10% of the money penalty-free, so you would never want to put the majority of funds into this long-term commitment. You should make sure to always have funds available in checking or savings accounts that you can get your hands on quickly in the event of an emergency.
Roger Ibbotson, Ph.D., is a professor emeritus of finance at the Yale School of Management.
In January 2018, he released a paper, “Fixed Indexed Annuities: Consider the Alternative.” In it, he concluded, “Annuities have, for a long time, deserved a place in retirement portfolios, and the evolution of the industry has made these vehicles more flexible and attractive.”* Based on the simulations run in his article, “Considering today’s low interest rate environment and our modest expectations for bond returns in the coming future, FIAs are an alternative to consider.”*
When considering an annuity, make sure to work with an independent agent who is able to shop your specific profile and objectives to see which insurance company can offer you the highest amount of income. I hope this article has given you a bit more education on this subject matter and helps you make smarter financial decisions in the future.
