In my 30-plus years in the retirement planning field, I have changed my opinion on how to best utilize resources in retirement. In the 90s, when all the market wanted to do was go up, having a growing portfolio seemed like the logical way to go. Then came 2000 – 2009 where there was a negative return in the market. For the last 10 years, I have been working exclusively with clients creating retirement income and the question always comes up about Annuities. I am not an all-annuity or an all-portfolio person. I am an income person and a risk management person. This shaped my planning, and I thought I would share why below.
When it comes to retirement planning, there are several options available to generate income, including a portfolio of investments and an annuity. While both options have advantages and disadvantages, an annuity can provide a more secure retirement income for individuals looking for guaranteed payments throughout their lifetime.
Here are a few reasons why a portfolio can be riskier than an annuity in retirement:
1. Investment Risk: A portfolio of investments is subject to market volatility and investment risk. The value of investments can rise and fall, and there is no guarantee that an investment will perform as expected. This volatility can make it difficult for individuals to predict the amount of income they will receive from their portfolio in retirement. Even a well-diversified portfolio can be impacted by economic downturns or unforeseen events, potentially leading to significant losses.
In contrast, an annuity provides a guaranteed income stream that is not dependent on market performance. The payments from an annuity are based on the terms of the contract, which can include guarantees for a specific amount of income over a defined period or for life. This provides individuals with greater predictability and stability in their retirement income.
2. Longevity Risk: Longevity risk is the risk of outliving one’s retirement savings. With a portfolio, the amount of income an individual receives is dependent on the performance of their investments and the amount of money they withdraw. If an individual withdraws too much or if their investments underperform, they may not have enough savings to last throughout their retirement.
An annuity can protect against longevity risk by guaranteeing income payments for life. This provides individuals with peace of mind and protection against the risk of outliving their retirement savings. Even if an individual lives longer than expected, they will continue to receive income payments for the remainder of their life.
3. Inflation Risk: Inflation is the rise in the cost of goods and services over time. Inflation can erode the purchasing power of retirement savings, making it difficult for individuals to maintain their standard of living in retirement. A portfolio of investments may not keep pace with inflation, leading to a decrease in the value of an individual’s retirement savings over time.
An annuity can protect against inflation risk by offering options that increase income payments over time. For example, an inflation-adjusted annuity provides income payments that increase with inflation, ensuring that an individual’s purchasing power is maintained throughout their retirement.
4. Behavioral Risk: Behavioral risk is the risk that an individual will make poor investment decisions based on emotions or biases. Behavioral risk can lead individuals to make impulsive investment decisions or to panic during market downturns, potentially leading to significant losses.
An annuity can protect against behavioral risk by offering a guaranteed income stream that is not dependent on market performance. This can help to reduce the temptation to make impulsive investment decisions or to panic during market downturns. An annuity can provide individuals with peace of mind and greater emotional stability during times of market volatility.
In conclusion, a portfolio of investments can be a risky option for generating retirement income due to investment risk, longevity risk, inflation risk, and behavioral risk. An annuity can provide greater predictability, stability, and protection against these risks. However, it’s important to note that annuities also have their own set of drawbacks, including limited liquidity, possibly higher fees, and potential limitations on inheritance. As with any retirement planning decision, it’s important to carefully consider the pros and cons of each option. If you have any questions, I would be happy to assist you in determining the best strategy for your individual needs and goals. To schedule a free initial consultation please reach out to my office.