When it comes to investing, most folks are seeking growth, income, safety and/or liquidity.
Most investments, however, don’t satisfy all these wishes. A typical growth investment often lacks safety, and a typical income investment often lacks growth. And finally, if you seek safety and liquidity, you often give up a higher income.
Finding the right balance is often the challenge, and why our grandparents often tell us not to put all our eggs in one basket. This is especially key if you are in or nearing retirement.
One problem with record-low interest rates is that creating a reliable income stream in retirement has become much more difficult. Interest rates are so low that investments in CDs and bonds no longer keep up with inflation, which means investors effectively lose money over time. Likewise, the traditional 60/40 portfolio—60% stocks and 40% bonds—has fallen out of favor because of the poor returns from the bond portion. This creates an issue for older investors who are reluctant to increase their exposure to an increasingly volatile stock market.
Annuities vs. Bonds
Annuities and bonds are popular ways for investors to generate an income stream. While both are considered "fixed income," bonds are more commonly used since they trade like stocks in the markets. Still, many financial experts argue that annuities are a better way to generate income in retirement because they can provide an income stream you can’t outlive.
The main difference between annuities and bonds is the nature of the relationship between you and the issuer. With an annuity, you are a party to a contract. With a bond, you are a lender. Another big difference is when you buy a bond, you get interest payments for a set period of time, and then you get your money back. Annuities often pay for the rest of your life, no matter how many years that is.
- Annuities can provide an income stream for a certain period or for life.
- With a bond, an investor lends money and gets regular interest payments for a fixed period; then, the principal investment is returned.
One risk you take as a bond investor is that interest rates might not remain at a level necessary to generate your desired income. The annuity owner doesn’t have that risk because payments are guaranteed for life. Also, as interest rates rise, bond values drop. This is why fixed index annuities are often suggested as a bond replacement these days, especially for retirees. They protect your principal and avoid the losses bonds can experience. And they provide reliable income, especially important in times of increasing market volatility.
Some Pros and Cons to Consider
Indexed annuities can provide an attractive “non-market” opportunity for investors. Rising interest rates generally translate to falling bond prices. Fixed index annuities don’t suffer those losses because the funds aren’t invested directly in the markets. Several distinct advantages over bonds include:
- Protection from market declines
- Elimination of bond-default risk
- Participation in positive performance of stock market indexes
- Tax deferral in non-retirement accounts
- Guaranteed lifetime income
- Investment-management simplification
- No investment-management fees
Of course, as with all investment opportunities, there are a few negatives when considering indexed annuities.
- Indexed annuities may have less liquidity than bonds. While you can usually withdraw up to 10% per year, there’s generally a fee on early withdrawals that exceed that.
- Longer time horizons (typically 7-10 years). It shouldn’t be problematic for long-term investors who don’t require short-term liquidity and normally invest in bonds as part of their portfolio. A longer term can also come with advantages, including higher rates.
The Bottom Line for Your Retirement Planning
This takes us back to why a diversified portfolio is so crucial in retirement. A fixed index annuity shouldn’t be the only answer to your income needs in retirement, but it may be an appropriate addition to your plan, especially if you expect interest rates to rise. Your blended portfolio should provide you with income, protection from losses, liquidity and growth—and make you feel less vulnerable when the market does what it does.
Give us a call to determine if adding a fixed-index annuity to your retirement portfolio is the right move for you. To learn more, or for a free white paper Annuities as an Asset Class, please contact us at 303.645.4800 or Impact@ImpactWealth.com.
Your Impact Wealth Team