An often overlooked but critical aspect of retirement planning is the sequence of returns risk, which highlights how the timing of investment returns can significantly impact how much money you have available when withdrawing your retirement savings. Annuities can be a great tool to help eliminate or reduce sequence of returns risk.
During the accumulation phase of retirement planning, investors are wisely told by financial professionals to invest with a long-term mindset because market fluctuations can be absorbed over time. However, as retirees transition into the distribution phase—when they begin to rely on their savings and investments to provide income—the timing of investment returns becomes critical.
Impact of Sequence of Returns Risk
To illustrate the impact of sequence of returns risk, consider a scenario involving two retirees who retire with identical savings but experience different sequences of market returns.
Retiree A experiences strong market returns early in retirement, followed by downturns later, while Retiree B faces poor returns initially, with a market rally occurring in the later years of retirement.
Despite starting with the same amount of savings, Retiree A may end up with significantly more wealth after the same number of years due to early returns. On the other hand, Retiree B could exhaust their savings prematurely if withdrawals coincide with market downturns, falling victim to a poor sequence of returns.
Annuities as a Possible Solution
Annuities may be able to serve as a great solution to mitigate sequence of returns risk. As a product designed to provide a steady income stream, income annuities can offer more consistency in the distribution phase than other traditional investment vehicles. Additionally, accumulation annuities with limits on downside loss can mitigate sequence of returns risk by providing protection from market volatility.
- Income Annuities: These annuities offer options for a guaranteed income stream for life, providing retirees with a stable financial foundation regardless of market fluctuations. By converting a lump sum into periodic payments, income annuities can help shield retirees from the adverse effects of poor market performance early in retirement.
- Registered Index-Linked Annuities (RILAs): With a RILA, retirees can benefit from higher potential market gains while having a measure of downside protection against market losses. This structure allows retirees to participate in market growth without bearing the full brunt of market downturns, therefore minimizing the impact of sequence of returns risk in the distribution phase.
While planning for retirement, it’s essential to consider not only how to accumulate wealth but also how to effectively manage and distribute that wealth. Annuities can play a pivotal role in mitigating sequence of returns risk by providing stable income streams and protection against market volatility. By incorporating annuities into a comprehensive retirement strategy, individuals can enhance financial security, maintain a desired standard of living throughout retirement and confidently navigate the uncertainties of market fluctuations.
Editor Norah Layne contributed to this article.
The views expressed here are those of the author and do not necessarily represent the views of TruStage.
TruStageTM Annuities are issued by CMFG Life Insurance Company (CMFG Life) and MEMBERS Life Insurance Company (MEMBERS Life) and distributed by its affiliate, CUNA Brokerage Services, Inc., member FINRA/SIPC, a registered broker/dealer, 2000 Heritage Way, Waverly, IA, 50677. Investment and insurance products are not federally insured, may involve investment risk, may lose value and are not obligations of or guaranteed by any depository or lending institution. All contracts and forms may vary by state and may not be available in all states or through all broker/dealers.