Where Do Annuities Fit in Your Investment Portfolio?
Why it matters
- Understand your options when preparing for retirement, including stocks, bonds, and the lifetime income of an annuity.
- There are several kinds of annuities. Have you investigated Registered Index-Linked Annuities (RILA)?
- Believe it or not, living longer than you expect could be a risk. Think about income that will last through a long, long life.
Annuities and you: A fit for (long) life?
The term “asset allocation” may come up when discussing financial goals and strategies with a financial professional. But what is that, and why does it matter? Fact is, life is full of uncertainties. Equities (stocks/mutual funds) are never a sure thing. Bonds may not provide the return investors seek. Even cash under the mattress can be under attack from inflation.1,2
And then there are annuities, which can provide consistency as other assets fluctuate, and can provide the option for a lifetime of steady income.3
Asset allocation is spreading some of that risk around. Essentially, it’s the adage of not putting all the eggs in one basket. Some asset classes can help guard against inflation. Others may offer stability. Even a boring savings account offers quick liquidity as a shelter from life’s unexpected emergencies.1,4
Unfortunately, there’s no one-size-fits-all formula (wouldn’t that be great). Every investor is different with individual goals. That’s where discussing available strategies with a qualified financial professional can help you develop a strategy that’s right for you.1
Your investment portfolio and risk
When building a strategy, investors and savers may consider the potential risks challenging their financial portfolio.
This one sort of explains itself. “Business Risk” is one thing, when a single company fails, and investor-held positions (stocks) are left worthless. Sure, stocks can go up. But they can also go down. That’s “Market Risk.” Over the long run, a diversified basket of stocks — such as a broad mutual fund with many holdings — tends to increase in value. However, not everyone has time to wait for stocks to bounce back. Remember the dawn of the COVID pandemic? From February to March, 2020, the broad S&P 500® — an index of 500 companies — fell 34%. That’s just the market.5
This one might not look obvious at first glance, it’s the “money in the mattress” conundrum. At first, it may look fine. The amount in the account hasn’t decreased. But with inflation risk, if prices rise, that money buys less. So even “being safe” isn’t always “safe.” (Spoiler alert, for the 12 months that ended in March, 2022, the U.S. inflation rate was 8.5%, the highest since 1981).5,6,7
This is the old “house rich, cash poor” situation, it’s when an investor has something worth something, but nobody wants it at the moment. When the investor needs cash (say, to pay a debt, an emergency expense, or just to live on) an asset may need to be sold at a discount because there’s little demand. This can hurt someone who invested in real estate and then the housing market tanks, or it can be an investment in any asset — like a bond — if there’s no demand.8,9
It might be hard to think of living longer as a “risk,” but for those who haven’t prepared for a long, long life in retirement, running out of money before running out of morning wakeups could mean lean years in old age. Lifelong employer pensions are being phased out, future Social Security payments could be reduced, and one study found the biggest risk for retirees is longevity. A 62-year-old woman today can expect to live to 86 (excluding factors such as family history and lifestyle).10,11
Asset classes: Back to school
When it comes to deciding where to save, grow, and preserve assets, investors have lots to consider. A balanced investment portfolio consists of several asset classes that together can help to address investment risks. Knowing which questions to ask could help start the process.
Owning a stock is owning part of a company, or in the case of mutual funds and ETFs, owning parts of lots of companies. Stocks can go up in value and be sold at higher prices, or a company may return some of the profits to investors in the form of dividends. Stocks provide the greatest potential for growth. Alas, stocks also provide the greatest potential for losses and for market risk.12,13,14,15
These are loans investors make to companies or governments in exchange for interest payments (nothing’s free, right?). Bond returns often move in the opposite direction of stock returns, making them a perfect complement to your stocks. But they come with their own risks.16
Maybe not always “king,” but nice to have. An emergency fund kept in cash may help alleviate liquidity risk while increasing inflation risk. An emergency fund can cover unexpected events: a health crisis, damage to a home or car, stuff like that. An emergency fund can help avoid selling an asset at an inopportune time or taking on debt. A Federal Reserve survey finds more than a third of Americans say they couldn’t pay off a $400 emergency expense on the spot.4,17
Annuities are investments with insurance components. They offer the potential for growth with a level of protection against losses and can be a strong hedge against longevity risk. Annuities may be the only insurance you actually want to use, a guaranteed income for a period you choose — even a lifetime. That sounds better than getting to use your health insurance or your auto collision insurance.3,18 Of course, any guarantees are based on the claims-paying ability of the issuing insurance company.
What’s this about annuities? Income for life? For those who’ve never thought about a financial solution to longevity risk, it may sound foreign. You pay into something and later receive income for life. This annuity calculator provides examples of how they can work. Modern annuities are also able to provide risk control beyond longevity to address volatility, interest rate risk, and inflation risk.
Annuities come in several varieties. A financial professional can help explain.18,19
Annuities are regulated by state insurance commissions and/or the Securities and Exchange Commission and may come with fees, expenses, and potential tax penalties for withdrawal before age 59 ½. Be sure to understand all details, and remember, an annuity is a contract between you and an insurance company — you may want to be sure it’s a company that will be around when it’s time to collect.18
One more thing, a RILA annuity (really)
And then there’s the Registered Index-Linked Annuity (RILA), a deferred annuity crafted with the intent to limit exposure to downside risk while generating returns based on the performance of a stock index or indexes without investing directly in stocks or securities. They’ve been called “buffered” or “hybrid” annuities based on their structure and can allow investors to tailor choices to meet individual risk tolerance. This could be an option for someone nearing retirement, seeking comparable market performance (with a level of downside protection), and interested in tax-deferred growth.22
Annuities, plugging the income gaps
When it comes to retirement income strategies, developing retirement plans, long-term investment hopes, and financial goals, no two investors are alike. But understanding potential gaps — and financial solutions designed to fill those gaps — can help. A worksheet can help investors understand retirement living expenses, what fixed costs the steady income of Social Security can cover, and where gaps in basic needs may exist, gaps that could be filled with regular, recurring income from available financial solutions. The Social Security Administration provides a way for people to see their own individual Social Security records and get an estimate on what they may expect to receive each month when they choose to receive benefits (and it’s free, ssa.gov/myaccount).23,24
When it comes to setting financial goals and charting a course for the future, understanding available investment options can help, and knowing what questions to ask may be a logical starting point. Financial, tax, and legal professionals can explain available solutions and help craft a plan as individual as you.
Things to consider
- You may live longer than you think as you prepare for retirement. A lot longer. There are financial solutions that can provide lifetime income, no matter how long your retirement lasts.
- Financial professionals can explain how an annuity with a lifetime rider could fill potential gaps in retirement income.
- Different asset classes seek to meet different financial challenges, including longevity and market risks. Understanding all the available options could help.
- “Asset Allocation,” Investopedia, March 2022
- “What Risks Lurk in Each Asset Class?” Morningstar, March 2022
- “Annuities: How to Turn Retirement Savings into Retirement Income,” Kiplinger, October 2022
- “Why an Emergency Fund Is More Important Than Ever,” Investopedia, August 2021
- “What Is Financial Risk Management?” The Balance, November 2021
- “What Investors Can Expect from High Inflation and Rate Hikes,” Knowledge at Wharton, Wharton School of Economics, February 2022
- “TED: The Economics Daily,” U.S. Bureau of Labor Statistics, April 2022
- “What Is Risk,” Investor.gov (Securities and Exchange Commission) accessed May 2022
- “Liquidity Risk,” Investopedia, May 2021
- “How Accurate Are Retirees Assessment of Their Retirement Risks,” Center for Retirement Research Boston College, July 2020
- “Retirement & Survivors Benefits: Life Expectancy Calculator,” Social Security Administration, accessed May 2022
- “Stocks,” FINRA, accessed May 2022
- “Stock Basics,” FINRA, accessed May 2022
- “Mutual Funds,” FINRA, accessed May 2022
- “Exchange-Traded Funds,” FINRA, accessed May 2022
- “Bonds,” FINRA, accessed May 2022
- “Report on the Economic Well-Being of U.S. Households in 2020 - May 2021,” Federal Reserve, accessed May 2022
- “Annuities, What Are Annuities,” Investor.gov (U.S. Securities and Exchange Commission), accessed May 2022
- “Social Security Is Worth More Than You Think, but Needs Your Help,” New York Times, updated September 2021
- “Six Ways to Pass Wealth to Your Heirs,” AARP, September 2021
- “Insurance, Money,” AARP, accessed May 2022
- “What Is a Registered Index-Linked Annuity (RILA)?” SmartAsset, March 2022
- “Social Security Workbook,” Transamerica, accessed May 2022
- “Create Your Personal My Social Security Account Today,” Social Security Administration, accessed May 2022
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Transamerica Resources, Inc. is an Aegon company and is affiliated with various companies which include, but are not limited to, insurance companies and broker dealers. Transamerica Resources, Inc. does not offer insurance products or securities. The information provided is for educational purposes only and should not be construed as insurance, securities, ERISA, tax, investment, legal, medical or financial advice or guidance. Please consult your personal independent professionals for answers to your specific questions.