Don't let a bumpy stock market affect your retirement planning
Market volatility聽like we鈥檝e seen so far聽this year can be particularly unnerving if you鈥檙e nearing retirement. Just one week into 2016,聽the S&P 500 lost almost 6% of its value 鈥� its聽听测别迟.
Exposure to the stock market allows pre-retirees to accumulate聽, but times like this remind us of the need for diversification and low-risk investments.
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滨苍肠辞尘别听, a type of insurance that acts like a fixed-income investment, are one option.聽Life聽annuities provide you with a fixed paycheck for as long as you live.聽These include products such as聽听(蚕尝础颁蝉),听聽(DIAs) and聽聽(SPIAs). Others, called period certain annuities, have different conditions.
Income annuities聽can provide income and diversification, and have聽the added benefit of protecting against longevity risk 鈥� the possibility of outliving your savings.聽My firm provides such retirement income products and we always tell clients that guaranteed income in the form of income annuities should never be the entirety of your nest egg, but these products can play an important role in retiree portfolios. Income annuities can:
1. Add diversification
Many investors save for retirement using 401(k)s and IRAs, which are often heavily invested in the stock market. This can mean huge potential gains 鈥� or potential losses. And these losses can be catastrophic if you鈥檙e nearing retirement during a down market.
Using a portion of your portfolio to purchase an income annuity will ensure that you have a steady paycheck in the future to supplement your聽Social Security or pension payments, if you have them. This not only makes planning easier, but insulates you from聽market volatility.
2. Reduce sequence of returns risk
聽should be a major concern for聽pre-retirees. To understand the concept, think of your portfolio as a basket of 100 shares,聽worth $50 each. To meet your expenses each year, you鈥檒l need to withdraw $100, or聽two shares. However, if the value of those shares drops to $25, you鈥檒l need to withdraw four聽next year. In the future, you鈥檒l continue to withdraw more shares from a smaller number of shares overall. This risk can be聽devastating to the recently retired,聽because they don鈥檛 have as much time for their portfolios to grow if and when the market bounces back.
Guaranteeing a portion of your future income reduces your exposure to sequence risk by removing it from the volatility of the market.
3. Provide psychological comfort
We all know that investing for retirement can be mentally and emotionally taxing. That鈥檚 another reason why some retirement savers use a portion of their assets to聽buy a fixed paycheck. A聽聽from consulting firm Towers Watson showed that retirees with annuitized income were happier overall than those without.
When you have聽an income annuity, you have a fixed paycheck that won鈥檛 run out. Allocating some of your assets to an income annuity today can buy you peace of mind for the future.
Understanding the trade-offs
Before you buy an income annuity, be sure you fully understand the downsides聽associated with these products, including the cost of inflation protection and a lack of liquidity.
In today鈥檚 market, most insurance companies offer options to include inflation protection 鈥� an annual cost-of-living adjustment to your annuity payments 鈥� with your income annuity, but it can be pricey, so it鈥檚 crucial you understand the mechanics and the costs associated with this option.
Additionally, most income annuities don鈥檛 let you聽access the capital before your first scheduled payout. Ensure that you have enough liquid funds to cover unforeseen expenses until then.
Finding trusted advice
If you鈥檙e considering purchasing an income annuity, get quotes from several insurance companies. You should also make sure that your agent聽is committed to acting in your best interest. Insurance agents must be licensed to sell annuity products and receive a flat commission on each聽sale. Asking each agent to disclose his or her compensation on the products enables you to evaluate the advice and make the decision that鈥檚 best for you.
聽is co-founder and COO of Abaris Financial, an online provider of income annuities, in New York. For more information, visit聽.
Learn more about Nimish on NerdWallet鈥檚聽
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