Is Buying an Annuity in a Bear Market a Good Idea?

In Safety-First
Retirement Planning: An Integrated Approach for a Worry-Free Retirement
I explain how including annuities with lifetime income protections alongside
other investments can lay the foundation for a more robust retirement income
plan that is less vulnerable to market downturns and outliving savings.

As the stock market experienced unprecedented growth over
the past eleven years, however, many people were naturally less interested in
the lifetime income options from pensions or annuities. Who wouldn’t rather
have all the assets today so they can invest them with the idea of earning high
returns? Research conducted by Indiana University’s Alessandro Previtero concludes
that individuals extrapolate recent stock market returns into the future and
become more comfortable with investment-based strategies when the market rises.

What a difference a month makes. Given the dramatic selloff
in equities following the coronavirus outbreak, many Americans who are approaching
retirement, or are already retired, are inevitably asking themselves if an
annuity may be a good idea after all. Previtero’s research demonstrates that annuities
are more popular after stock markets decline.

When thinking about the role of annuities in a retirement plan in today’s extraordinary climate, however, many people will contemplate if it is prudent to buy an annuity after the market has already dropped. Should one wait for markets to rise again?

The easiest way to answer this question is to think in terms
of the funded ratio for retirement. This requires calculating the
household’s total assets and liabilities. Assets include values for the
financial portfolio and other real assets, as well as the present discounted
value of other potential income sources, including Social Security, pensions,
annuities, part-time work, etc. Liabilities include current debt such as a
mortgage or loan balance, as well as the present value of lifetime spending
needs and taxes.

Next, divide total assets by liabilities to determine the
funded ratio. If it is 1 (or 100%), then sufficient assets are available to
cover liabilities. The plan is precisely funded, but vulnerable to losses
derailing it. If the funded ratio is greater than 1, a retiree enjoys the
flexibility which comes with having more than needed. If it is less than 1, a
retiree is underfunded. When underfunded, options include reducing spending
plans, working longer, or making a Hail Mary pass and taking on more risk with
one’s investments. (The final option is not recommended.)

In today’s bear market, we are more interested in those who
were overfunded before the recent market losses on account of the prolonged
bull market. Today, those who have experienced portfolio losses will be less
funded than before, but for those who still have enough assets to meet their
goals, an annuity can still be a viable option. After all, the goal of true retirement
income planning is not to earn a high investment return, but rather to actually
be able to fund all of their financial goals for retirement, including have
enough income to cover essential monthly expenses in retirement.

Following a steep market downturn, deferred annuities are
particularly attractive given their guaranteed lifetime income provisions that
offer both liquidity and upside growth potential, while providing downside
protection to support spending even if the market continues to drop. With these
deferred annuities, one does not have to “lock in losses” as the underlying
assets can still have the opportunity to grow. They may just grow a bit less
than otherwise because of the cost for the insurance to protect spending from
further market losses. But if this protection helps a retiree to keep invested
in the markets because they don’t have to be as concerned about market losses,
then it can provide a great benefit. Their goal is protected on the downside
but still keeps exposure on the upside.

Annuities can also offer some advantages in terms of tax
deferral when purchased inside of a taxable account. But the problem with
taxable accounts is the need to sell assets and pay taxes on the gains. A
potential silver lining of the recent market losses is that taxes due may be
less and there may be opportunities to harvest losses on more recent purchase
that can offset gains as a part of funding the annuities, without leading to a
big tax bill.


Originally posted at

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