There's no way to predict the direction of the markets in those critical years just before and after you shift from saving to withdrawing from your retirement accounts. That can be an uncomfortable feeling. "For many retirees, when they start to withdraw from their retirement accounts, it can feel more important than ever to be careful about managing risk," says Naveen Malwal, institutional portfolio manager with Strategic Advisers, LLC, the investment manager for many clients who have a Fidelity managed account.
When you're feeling uncertain, you may be tempted to sharply shift your asset allocation away from stocks or even pull out of the markets altogether. But that strategy has the potential to backfire and leave you short on cash years down the line. "Investing very conservatively in retirement can lead to less income for retirees, plus they may have a harder time keeping up with inflation," Malwal explains.
Historically, maintaining an allocation of a well-diversified mix of stocks, bonds, and other assets like cash throughout retirement has generated steady growth and income over the long term. But if you think you would struggle to tolerate volatility, one option to consider is combining a diversified, managed account with a fixed lifetime income annuity. With this type of annuity, you give a lump sum of money to an insurance company, and in exchange the insurer pays you a regular stream of income for the rest of your life.
Knowing your essential living expenses are covered by reliable lifetime income can offer a greater sense of security and help prevent you from making an emotional decision to pull money out of the market at the wrong time. The income annuity removes market risk for the portion you invest, and similar to a pension, annuity income can be received monthly and can feel akin to a paycheck you receive in your working years.
However, as with all financial products, income annuities come with certain tradeoffs, including having no or limited access to assets. For these reasons, Fidelity suggests dedicating a portion—not all—of your assets toward an annuity.
Protection against retiring in a bear market
Consider the hypothetical example of one couple, Jordan and Shawna, who retired in early 2008, just as financial markets were experiencing bouts of volatility. The couple met with their financial advisor prior to retirement and calculated that after Social Security and pension income, they would need $40,000 per year to meet their essential living expenses, with annual increases for inflation.
Because they felt uncomfortable about staying invested through periods of market volatility, Jordan and Shawna decided to invest 30% of their savings in an immediate fixed income annuity, and the rest in a diversified, professionally managed account.
Besides lowered stress, the consistent guaranteed income paid to Jordan and Shawna gave them greater comfort to remain invested through times of volatility. In 2008, one of the toughest years on record for stocks, their investment portfolio lost 30%. However, over the following 2 years, the markets rebounded, with their portfolio balance returning to nearly where it had started in 2008. "In scenarios like this, the annuity is supplying a good chunk of the income for the retiree's journey so the portfolio balance is less affected by withdrawals and the investors may feel less stress," explains Malwal. The consistent income allowed Jordan and Shawna to participate in market performance and at times even lower the amount needed from their investment portfolio to meet their essential expenses.
In this educational example, shown in the graphic below, Jordan and Shawna maintained a comfortable and consistent withdrawal rate from their portfolio for the next 15 years, which, in combination with the annuity, allowed them to easily cover their expenses and stay invested through some historically challenging market conditions. "This couple went through the 2008 great financial crisis, 5 bear markets, a global pandemic and recession, and numerous other challenging market events. And they still managed to stay comfortably retired," says Malwal. "This example shows how having a long-term financial plan and sticking with it can help investors in the long run."
Portfolio Advisory ServicesSM Account—Total Return Blended Growth with Income1 and Annuity
Past performance is no guarantee of future results. Diversification and asset allocation do not ensure a profit or guarantee against loss. For informational purposes only. Returns for individual clients will vary.
Based on the performance of a composite of Fidelity Wealth Services accounts managed using the Growth with Income asset allocation, the total return investment approach, and blended investment universe. Please be aware that the return information differs, perhaps significantly, for an account that is not managed using the same configuration of strategy characteristics as the composite shown above. The Growth with Income asset allocation, total return investment approach, and blended investment universe were chosen because they are the most commonly used asset allocation, investment approach, and investment universe in the program as of 12/31/23. Please speak to your Fidelity representative for information about the performance of other strategy characteristics available through the program. Performance shown is pre-tax, and the assessment of taxes will reduce returns. Please see disclosures for additional important information regarding performance returns.
Additional Important Annuity Income Assumptions. The annuity payout rate is based on rates existing on 1/10/2008 from among immediate fixed income annuities distributed by Fidelity Insurance Agency, Inc. Annuity payout rates are subject to change, and such an annuity purchased today may provide significantly less or more income than is depicted in this illustration. When included with a joint-life fixed income annuity, a cash refund feature guarantees upon the death of the last surviving annuitant beneficiaries will be refunded any difference between the original annuity purchase amount and the annuity payments already received.
Reduced potential for asset growth
While past performance is no guarantee of future results, for the most recent 20-year period 2003 to 2023, a portfolio of 60% stock/40% bonds returned about 7%.4 By purchasing an income annuity, you forgo the option to keep those assets in the market. You also generally have limited access to the money, even if your situation or income needs change. However, some fixed income annuities offer a guaranteed lifetime withdrawal benefit which provides access to your investment. Your income may be lower for the tradeoff of access.
In addition, the payment from a fixed income annuity does not change which may later be impacted by inflation. One potential way to reduce this risk is to select a cost-of-living adjustment feature, which can increase payments each year by a certain percentage. However, this will generally reduce the amount of your initial annuity payment.
Reduced potential for managing retirement income taxes
Depending on how you fund your income annuity, it is generally taxed at the retiree's ordinary income tax rate for a portion of the investment. While some withdrawals from investment accounts may also be taxed at ordinary income tax rates, others may benefit from favorable tax treatment, such as gains on investments held for more than a year, which are generally taxed at the lower long-term capital gains rate, and income from municipal bonds, which is often tax-free. "In our taxable managed accounts, we use tax-efficient investments, tax-loss harvesting, and other tax-smart investing techniques5 to help to reduce your overall tax liability," explains Malwal.
Fitting annuities into your estate plan
An income annuity can help alleviate concerns about outliving your savings. But many investors also hope to pass a significant part of their assets to their heirs someday. Depending on the type of annuity you choose, your heirs may still receive some benefit, especially if you pass sooner than expected. However, they will generally receive less than they would if the money had stayed in the market.
Talk to a professional
In the end, no retirement investing plan can be successful if it isn't suited to your risk tolerance level. More important than short-term movement of the market is your ability to stick to your plan. A financial professional can help you assess whether or how you might benefit from annuitizing a portion of your savings. "Finding that balance between growth and greater peace of mind can be a challenge during retirement," says Malwal. "But with a plan in place and a disciplined approach, retirees are likely to live through many periods of market volatility and still maintain a comfortable retirement."