Wade Pfau, Ph.D., CFA, RICP®

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.

Retirement Researcher is a SEC registered investment adviser. The content of this publication reflects the views of Retirement Researcher (RR) and sources deemed by RR to be reliable. There are many different interpretations of investment statistics and many different ideas about how to best use them. Past performance is not indicative of future performance. The information provided is for educational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy or sell securities. There are no warranties, expressed or implied, as to accuracy, completeness, or results obtained from any information on this presentation. Indexes are not available for direct investment. All investments involve risk.

The information throughout this presentation, whether stock quotes, charts, articles, or any other statements regarding market or other financial information, is obtained from sources which we, and our suppliers believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Neither our information providers nor we shall be liable for any errors or inaccuracies, regardless of cause, or the lack of timeliness of, or for any delay or interruption in the transmission there of to the user. RR only transacts business in states where it is properly registered, or excluded or exempted from registration requirements. It does not provide tax, legal, or accounting advice. The information contained in this presentation does not take into account your particular investment objectives, financial situation, or needs, and you should, in considering this material, discuss your individual circumstances with professionals in those areas before making any decisions.