If we told you that you could go to Vegas, play blackjack and never lose money, you might tell us to get fitted for a straightjacket (and that would be an apt recommendation). Now, what if you never lost your money on a losing hand but when you won, you only got half of the pot. Still pretty great, right? But as we all know, this never happens in Vegas.
So, what does this have to do with retirement? One crucial component of a comfortable retirement is reliable income. And, a common way people achieve it is by utilizing annuities. Annuities are often misunderstood and, as a result, some people find themselves with an annuity that doesn’t meet their income needs. There are a lot of nuances when it comes to annuities and due to the level of complexity and variation, they can’t possibly be covered entirely in this short piece. But for the purposes of demonstration, we’ll talk a little about the two main classifications of annuities, fixed and variable.
A fixed annuity pays out a guaranteed rate of return, providing less risk compared to variable annuities, but the tradeoff is that you typically get a more modest return. While the fixed annuity provides a guaranteed return, you forego potential growth that could be obtained by placing your funds in a higher risk investment. However, if you are relatively risk-averse, fixed annuities may be a good fit for you. Variable annuities, on the other hand, are tied to stocks, mutual funds, precious metals and other commodities that fluctuate in value. This means that when the underlying assets are performing well, you may realize higher returns. But if the assets aren’t performing well, you’ll take a hit. Bear in mind that your returns on both types of annuities also depend on the arrangement you have with the insurance company selling you the product and can include other features like income riders. You also should be aware that high and often hidden fees which you’re required to pay whether you’re up or down in the market can cannibalize your gains.
Now, let’s go back to Vegas! Another variation on annuities is the fixed index annuity (FIA). This one is like the “blackjack safety net”. The FIA allows you to protect your principal by shifting the risk to the insurance company selling you the annuity. Like variable annuities, FIAs are tied to the performance of a stock market index but there are caps on your potential returns. With the blackjack analogy in mind, you don’t lose money in these annuities if the stock market performs poorly, but you are able to realize about half of the returns. While FIAs provide lower potential returns, they’re more reliable because they mitigate a certain amount of risk. Additionally, FIA accumulation annuities don’t incur fees.
So, when we say that you can make risk-free investments for reliable income during retirement, should you question my sanity? Any financial vehicle associated with stocks or other speculative instruments involves some risk, and you should always consult a trusted financial advisor about your options. But in the world of finance, fixed index annuities are a much safer and more stable way to accumulate capital, providing solid income and peace of mind for your retirement.