Annuities in Portfolio ManagementWhether you’re inching up on retirement, or you’re already there, portfolio management needs to move from asset accumulation to income production.

The “traditional” retirement asset allocation approach is to pick a mix of equities and bonds and a ‘reasonable’ withdrawal rate, and then hope for the best.   Honestly, retirement planning for most money managers is little more than a throw of the dice.

But today’s annuity options can offer a wide range of advantages, including the ability to attain better than average growth while at the same time keeping your principal safe. On top of that, rather than concerning yourself with an asset allocation model that carries the risk of running out of income if you live “too long”,  an annuity can provide you with a guaranteed stream of income for life.

But consider for a moment using annuities as an alternative safe money allocation in your portfolio. This is not just sales copy either- renowned academics such as Moshe Milevsky and Wade Pfau have shown that using various types of annuities can also reduce the overall cost of funding your retirement.  So lets uncover the range of unexpected benefits available to you when you add an annuity to your overall financial mix.

Annuities in Portfolio Management

Why Annuities Might Be Appealing – Even If You Already Have an Income Stream in Place

If you’ve been caught in the roller coaster stock market (again!) and the thought of having to swim upstream in yet another market correction brings tears to your eyes, an annuity could provide a breath of fresh air for your portfolio. In fact, even if you already have a secure stream of income in place, you still might want to consider adding an annuity to the mix.

The main advantages to owning the right annuity are the benefits for you in retirement, such as:

  • Safety – The right annuities will always keep your money safe, regardless of what happens in the market. With the right annuity in place, you could attain a higher yield than that of bonds, yet still be able to sleep at night, knowing that your money won’t be subject to the next market downturn.
  • Growth – There are certain types of annuities that are actually designed for capturing growth when its underlying investment(s) perform well, yet won’t lose value if the assets being tracked take a nosedive – essentially giving you the “best of both worlds.”
  • Income – At their core, the primary goal of annuities is to provide an income stream. This income may flow in for a set number of years, or alternatively, if the life income option is chosen, you – and possibly even your spouse or partner – can continue to receive a steady and guaranteed income for the remainder of your (and their) lifetime.

But there are many different types of annuities available in the market today. So, you can’t just blindly pick one and hope that it does what you want it to do.

Rather, having a guide to show you the way can point you in the right direction – but only after you have a good understanding of how the annuity works, and what you can expect it to do for you.

Considering the Index Annuity

In your quest to better understand annuities, it is likely that you have come across at least some information about index annuities. These financial products earn their return primarily based on the performance of an underlying market index, such as the S&P 500.

When the underlying index performs well, the annuity is credited with a positive return – oftentimes up to a stated cap, or maximum. This is a “tradeoff” of sorts, because when the underlying index performs poorly during a given year, the annuity is not credited with a negative return, but rather simply with a 0%.

In addition to keeping principal safe, this “no loss” concept with index annuities offers added benefit, too, in that there is no need to make up for previous losses before the funds in the annuity can continue growing. In other words, these funds can simply pick up where they left off when the underlying index performs in the positive again.

The Place for Lifetime Income In Your Portfolio

The predominant marketing push around index annuities presents them coupled with income riders, to offer guarantee lifetime income.  Truthfully, income rider index annuities have a primary added benefit that is not to be ignored- that of longevity protection, ensuring that you will have an income stream, no matter how long you may need it. Because no one knows exactly how long they will live, it can make retirement income planning with “finite” income streams quite difficult.

Because people are living longer lifespans today, most people are concerned about running out of income before essentially “running out of time.” This is what is officially termed as “longevity risk.”

Annuities with guaranteed lifetime income streams can help to solve for longevity risk by ensuring that you will have income that you can count on for the remainder of your lifetime, regardless of how long that may be.

But allow us to leave the income rider aside for a moment and explore the benefits of the simple growth oriented index annuity alone, as a highly valuable portfolio management tool.

How to Properly Position a Growth Index Annuity in Your Portfolio

There are a couple of ways that a growth index annuity could be positioned in your portfolio, depending on what your particular goals may be. First, these annuities are oftentimes used as a bond alternative.

Yet there are several features that can actually set an index annuity ahead of bonds. Here again, the issue of safety comes into play. Unlike bonds, an annuity is not interest rate sensitive.  When rates rise, bonds lose value.  Not so with an annuity. You’ll know what you can anticipate going forward regardless of what happens with interest rates, and the annuity may actually offer you higher yield potential.

Why should this matter?

Let’s take a look at an example to help explain. Assume you are a 65 year old male with a life expectancy of thirty years, and you have a  portfolio of $400,000 and need to ensure that you will have a steady income stream of $1,000 per month throughout that period of time.

You could purchase a bond to accomplish this, however you would actually have to pay much more for the bond than for the annuity. To achieve $12,000 per year from a bond, you would need roughly $350,000 investment at current yields of +/- 3.5%.  To secure the income needed, your remaining portfolio is reduced to just $50,000

By contract, $12,000/ year costs just $173,000 as of this writing for a lifetime income stream for this individual.  Because of the lower initial investment, your remaining assets of over $225,000  are free to be invested for growth, provide for inheritance, or any other need.  Using the annuity is a far superior allocation.  And the overall portfolio is far safer as the necessary income is guaranteed.1

In fact, according to Wade Pfau, income annuities can essentially be considered as actuarial bonds with an average maturity that is equal to life expectancy. Further, not only can the inclusion of an income annuity allow for greater income throughout retirement, simulations show that the risk pooling feature of annuities are a more significant factor in boosting retirement income than is the greater upside potential that is offered through increased reliance on investments.2

In addition, the annuity can also offer you much more flexibility with your savings. In this case, you can typically withdraw a certain amount of money from your annuity each year without incurring a penalty (even during the surrender period). The same cannot be said for bonds. In fact, any type of early bond sale will generally equate to a locked in loss.

With all of this in mind, you could position the annuity such that you take advantage of its penalty-free withdrawals in order to supplement your retirement income stream. In doing so, you can safely protect assets, while also allowing your other investments time to mature. This, in turn, could allow you time to avoid having to make systematic withdrawals during down markets.

Added Benefits of Using a Growth Focused Index Annuity

In addition to the combination of growth, safety, and the possibility of penalty-free income, there are some added benefits to using a growth-focused index annuity strategy. For instance, if a growth-oriented index annuity with liquidity is set up properly, it could allow you significant cost savings of roughly 25% or more, as compared to the cost of adding an income rider to the annuity.

Plus, on top of getting more benefit for less money, you could also see more overall output. As an example, an annuity with a costly income rider can take, on average, 20 years to recoup what was contributed in premium. And, if you don’t purchase the annuity until roughly age 60, you could be entering your ninth decade before you essentially “break even.”

On the other hand, when a growth-oriented index annuity is constructed correctly, you can enjoy more income for more years because you can use the annuity for income stream at a much younger age, and most importantly turn it off if not needed.

Who Should Consider an Index Annuity as an Added Growth, Safety, and Income Tool?

For all of the reasons stated above, shifting at least a portion of your current safe money allocations to a growth-oriented index annuity could be a very smart move. That’s because you will be drawing from all assets in the portfolio to cover your retirement expenses, without having to be considered about portfolio “drawdown” risk.

In this case, when the market is not doing well, you are able to draw income from the annuity – which allows you to also avoid selling securities at a low value, and to balance the entire portfolio, which can result in much better long-term performance.

The bottom line here is that by going with this type of strategy, you can avoid the risk of “reverse dollar cost averaging,” and at the same time increase your safety via a solid base of assets to withdraw money from if you need to – and that also allows your other assets plenty of time to recover in the event of a market downturn.

Is this the right strategy for you? You be a good candidate if you:

  • Have a goal of retiring at age 62 to age 65, but you are waiting until age 70 to fully maximize your Social Security payments (i.e., based on the delayed income credit of roughly 8% per year between your full retirement age and age 70), and you need a way to fill the income “gap.”
  • Your assets comfortably exceed your current income needs.  This works best when your income is +/- 5% of your total assets.

How to Take the Next Step for Maximizing Your Income and Growth Generating Portfolio

The longer your anticipated life expectancy, the more you will want to utilize strategies that will maximize lifetime income, and conversely, the shorter your life expectancy, the more you should ideally opt for maximizing current income methods.

In any case, you only retire once. So, it is essential to put together a comprehensive retirement income plan with the help of an income specialist. At DCFAnnuities, we are specialists in analyzing annuities and retirement income strategies that reflect your specific objectives, risk tolerance, and time horizon. For more information, or for a no-obligation consultation, Contact DCFAnnuities today.