How Annuities Can Help Guard Against a Decline

When you’re saving for retirement, market dips are uncomfortable but manageable; you have time to recover. Once you start drawing income from your portfolio, though, the math changes dramatically. A sharp decline early in retirement can devastate your long-term income plan.

This phenomenon is known as sequence-of-returns risk, which is the danger that poor market performance at the wrong time (especially early in retirement) drains your nest egg too quickly. Even if the market rebounds later, your portfolio may not recover because you’ve been withdrawing funds to live on while the balance was down.

Protecting against that risk means having a portion of your assets that won’t lose value in a downturn, providing steady cash flow to fund your income needs during volatile markets.

Annuities can be confusing because the word covers a wide range of products, each with very different levels of risk and protection.

• Variable Annuities: These are often misunderstood; they can look a lot like mutual funds. While they offer the potential for market-based growth, they do not protect principal from market declines. The value of a variable annuity fluctuates with the performance of the underlying investment options. If the stock market falls, your account value can decline as well. Some variable annuities offer optional riders that provide income guarantees (like lifetime income riders), but the account value itself remains exposed to risk. The only way to benefit from the guarantee provided by a lifetime income rider is to convert the entire account value to a lifetime income, generally an irrevocable decision.
• Fixed Annuities: These are the most straightforward. With a fixed annuity, the insurance company guarantees a set rate of return for a specified period. Your principal is protected, and your earnings are predictable.
• Fixed Index Annuities (FIAs): This is where things get interesting for risk-averse retirees. A fixed index annuity credits interest based on the performance of a market index (such as the S&P 500), but with no downside exposure. When the market rises, you can earn interest up to a cap or participation rate; when it falls, your account simply earns zero that year, not a loss. The interest earned each year is credited to the account, creating a new account value floor, so a future decline in the market will not reduce the account once the interest has been earned and credited to the account.

That combination of growth potential without market loss is why fixed index annuities have become popular for retirees who want to stay connected to market opportunity but can’t afford another 2008-style decline.

Unlike investments held in brokerage accounts, annuities are issued by insurance companies and come with contractual guarantees. The company’s financial strength matters, of course, but these products also benefit from an additional layer of security: state guaranty association programs. These annuities are not FDIC-backed like bank accounts, instead they participate in these state-by-state guaranty programs.

Every state maintains a guaranty association to protect policyholders if a licensed insurer were ever to fail. Coverage levels vary by state, but when paired with the strength of a reputable insurer, this dual safety net is unique in the financial world. Few other instruments combine guaranteed income, principal protection, and state-backed safeguards.

When the market is at or near all-time highs, it can be wise to “take some chips off the table.” For those entering retirement, this doesn’t mean abandoning growth entirely, it means segmentation.

One approach to consider is to carve out an amount roughly equal to five years of planned retirement income and place it into a properly structured fixed or fixed index annuity. This portion becomes your safety net or a safety bucket, money you can draw from if the market declines, giving your other investments time to recover.

For example, if your retirement income need is $80,000 per year, setting aside about $400,000 in a protected annuity could ensure that the first several years of retirement income are insulated from market volatility. That protection can make all the difference in whether your overall plan succeeds when markets decline.

Each annuity has its own strings attached, which often include a limit to the amount of the account that can be withdrawn in any particular year (often 10%), so read the fine print and plan strategically so you’re not subjecting yourself to unnecessary fees owned to the insurance company. 

You don’t have to choose between safety and opportunity. By pairing traditional market investments with the right type of annuity, you can protect your income, manage sequence-of-returns risk, and sleep better knowing that part of your retirement income is shielded from market storms.

Markets will always rise and fall, but your retirement lifestyle shouldn’t have to. Taking proactive steps while markets remain strong can help ensure that the next correction doesn’t derail your lifelong financial goals.

If you’re wondering whether an annuity might make sense in your retirement plan, schedule a free consultation with Adam and Dave at Fourth Dimension Financial Group. Together, we’ll review your income strategy, explore your options, and help you build a retirement plan that feels secure no matter what the market does next.