The U.S. government recently reported that as a result of the pandemic, Social Security’s main trust fund will be depleted in 2033, a year sooner than previously forecast, indicating that the system’s financial strength is eroding.
But Social Security isn’t going bankrupt, it will continue to send checks to tens of millions of Americans – it may just provide less income to retirees in the future.
The Social Security news sends a clear message: retirees and future retirees need to take responsibility for their futures and understand their dependence on the unpredictable performance of financial markets. Taking action may require a variety of tactics to diversify their portfolio and help ensure retirement savings last.
Annuities are one way to bolster retirement income. Like Social Security, annuities can provide a steady stream of lifetime payments. However, annuities are an insurance contract. The insurance company will uphold its guarantees as long as the rules of the contract are followed.
Annuities: Redesigned for modern times
The Social Security Administration projects that one in three 65-year-olds today will live to age 90. One in seven will live past 95. Annuities can help people address the concern of outliving their money and have adapted over time to meet changing needs.
Longevity risk is not the only concern. Retirees need to factor in market risk such as volatility, inflation and bad timing. More accurately referred to as “sequence of returns” risk, a person planning for retirement faces a risk that the market may go down significantly late in a working career or early in retirement, leaving the individual with less or even no time to benefit from a market recovery.
Annuities, specifically variable annuities (VAs), fixed indexed annuities (FIAs), and registered index-linked annuities (RILAs), were designed specifically to address these challenges.
Understanding your options
VAs were originally introduced as an alternative to fixed annuities. Buyers wanted the chance to benefit from rising markets by investing in a menu of mutual funds. While higher returns were possible, the buyer was also exposed to market risk which could result in loss. The demand for more protection from loss grew out of the three major market declines in the 21st century. While they suffered a downturn, recent market conditions have offered a rebound and VAs may again be an appropriate choice for those who are willing to accept higher risk for the potential of higher returns.
The low interest rates combined with bond market volatility in the mid- to late-‘90s solidified the need for a product that provided more opportunity for growth potential. As a result, the FIA was introduced. Earnings in a FIA are based on interest credits tied in part to the performance of an external index. They offer some of the growth potential of VAs but with limitations on growth potential that support guarantees that 100% of principal is protected from market loss. People generally buy FIAs because they want the chance for growth without any risk of losing what they’ve already saved due to market downturns.
The newest addition is the RILA, which offers some of the higher growth potential of VAs with a level of protection like the FIA. Like a FIA, growth is determined by interest credits based in part on movement in a stock market index. Unlike a variable annuity, RILAs have features that may limit growth potential but provide a measure of protection due to market downturns.
What’s right for you?
Investors today have more choices. When shopping for an annuity, it’s important that people consider the financial strength of the company. Annuities are often expected to make payouts for decades, so it is critical to pick a firm with a solid balance sheet and a strong reputation.
The financial future is always hard to see, especially when looking out over 20 or 30 years. There will be market ups and downs and occasionally, there could be something that comes out of the blue—like the Covid-19 pandemic did in 2020—that disrupts even the best-laid plans. Given all that uncertainty, it can make sense to have lifetime streams of income that will be there no matter what happens. Social Security historically has played that role. So have annuities. Annuities aren’t a magic bullet, but they can help provide peace of mind in volatile times.
It is important to remember that like Social Security, annuities are typically not meant to provide all of an individual’s retirement income. They are best thought of as part of a diversified portfolio. Investors, especially those with a long time horizon, may still need to own equities which will grow over time. But annuities provide income and a level of security that may make it easier to sleep at night.
Rod Mims serves as senior vice president, distribution, at retirement services company Athene USA, which sells annuities. In his role, he works to set Athene’s sales strategy, working closely with marketing, compliance, operations, technology and product development to drive performance.