One of the concerns facing retirement income may be the sequence of returns. Market losses during retirement can potentially have a lasting impact on retirement funds. When it comes to sustaining retirement income, people often place importance on the average rate of return. However, what might be more impactful is not the average return but the order of returns.
Also known as sequence risk, this refers to the risk of adverse market returns that can occur late in a person’s working years or during the early years of retirement. Suppose a market downturn happens during this period. In that case, it can potentially have a large impact on retirement savings and an overall financial portfolio since there is less time to recover from those losses. Let’s explore a hypothetical example of sequence of returns risk. In the two hypothetical examples provided, scenario A begins taking withdrawals in 1998, and scenario B begins taking withdrawals just two years later in 2000.1 Both have $500,000 at the time withdrawals begin. Twenty-one years later, with just a difference of two years from when withdrawals started, scenario A still has over $100,000, while scenario B’s account is depleted by year 15. For those looking to help mitigate the risk of potentially outliving retirement savings, a fixed index annuity (FIA) might be an option.
While one can’t predict what the market will do, a FIA can offer a balance of protection from market downturns and growth potential. Using FIAs, there is the potential for interest to be credited based in part on the performance of specific indices without the risk of loss of premium due to market downturns. In addition, FIAs can help with concerns about depleting funds due to some of the product’s specific features, such as annual reset and financial stability.
An annual reset feature of many FIAs locks in interest credits, meaning index gains cannot be lost due to market decreases. The “annual” reset feature applies to credit terms that span one year. For terms longer than a year, the reset feature coincides with the length of the term. This feature helps both in growing and in protecting retirement nest eggs; not only will you not lose value from market downturns, but the new starting point for future growth calculations is the lower index value (assuming a market downturn.)
Fixed index annuities are designed to provide reliable lifetime income. Comparing the risk of FIAs to other popular retirement planning options, we see that it is on the lower end of the risk spectrum. Premiums cannot be lost due to a market downturn. Adding a fixed index annuity can serve to complement many retirement portfolios, including those on the higher side of the risk spectrum because they offer protection from market downturns and potential for growth. For many, fixed index annuities may be an attractive addition to their retirement portfolio to help mitigate concerns regarding the sequence of returns risk or to help achieve retirement income goals.
1 Source for chart: Marcro Trends
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38471R-14 | PRT 12-25
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