Fixed annuities seldom yield much more than 3% a year, which means your real return – the return after inflation – is essentially zero. Instead, retirees should consider growth-oriented fixed indexed annuities (FIAs) and/or so-called structured annuities.
Plain vanilla fixed annuities are out. Instead, retirees should strongly consider investing in growth-oriented fixed indexed annuities (FIAs) and/or so-called structured annuities.
Inflation is Back, Impacting Retiree Investment Strategies
A serious economic issue – briskly rising prices – is gripping the U.S. economy and unlikely to fade. For the first time in a long time, inflation is up – way up – and contrary to multiple statements from the Federal Reserve, this will probably not be transitory. The situation could easily persist for years, especially if legislation is passed that would generate trillions of additional dollars in infrastructure and societal-related spending.
This is bad news for people who wouldn’t be major beneficiaries of such spending and especially retirees, most of whom live on fixed incomes. Yes, retirees get Social Security payments, which rise in tandem with inflation, but other sources of income, such as pensions, are static.
This means most retirees have to monitor their spending more so as not to run out of savings in their lifetime. Those who have been financially conservative may need to increase equity exposure due to the stock market’s history of outperforming other asset classes during an inflationary environment. Even if the stock market rises only modestly in coming years, it will almost certainly fare better than bonds because interest rates rise with inflation, undercutting the value of bonds.
Highest Inflation in 13 Years
Over the past year, inflation is up more than 5%, compared to 2% or less in previous years. Notwithstanding what the Federal Reserve says, 17 months into the Covid-19 pandemic, many supply chains remain highly constrained, continuing to boost prices. As just one example, take semiconductors. A severe shortage has undermined automobile manufacturing and is expected to continue doing so over the next year or two. The used vehicle market has also seen a sharp increase in prices due to the lack of new vehicles available for purchase.
A good way to think about inflation is to view it as a ubiquitous hidden fee charged to you every year. It doesn’t show up as itemized items in your bills, but rather in terms of what you can buy with your dollars.
Even if the inflation rate eventually falls to a seemingly modest 3%, that is still a third higher than the Fed’s target inflation rate of 2% and would take a huge bite out of your retirement income over 20 years. This is the life span of many retirees, especially if they retire at the relatively young age of 62. According to Kiplinger’s Personal Finance, if you need $60,000 in your first year of retirement today, in 20 years you would require more than $108,000 to match the same purchasing power.
How Retirees Can Cope
So let’s return to how retirees should react on the investment front. Plain vanilla fixed annuities are out. They seldom yield much more than 3% a year, which means your real return – the return after inflation – is essentially zero. Instead, retirees should strongly consider investing in growth-oriented fixed indexed annuities (FIAs) and/or so-called structured annuities. For those who have already invested in them, they should consider enlarging their investment if they are in a position to do so.
FIAs and structured annuities provide access to the stock market but, unlike the case with mutual funds or exchange traded funds, include downside protection. The appeal of FIAs is that owners don’t lose money in a bear market (in exchange for a piece of market index returns in a good year.) Structured annuities can still lose money, but much less than, say, a mutual fund, because of the aforementioned protection. Several structured annuities, for example, safeguard investors from the first 10 percentage point decline in the underlying index over the first year or two.
Here is a structured annuity and two growth fixed indexed annuities (FIAs) that prospective annuity buyers might want to consider. The FIAs are so-called fee-for-rate offerings that charge an annual fee or equivalent of 1% annually in exchange for a higher index participation rate on select low volatility indexes that invest, in part, in stocks.
- Athene Amplify. This is among the best structured annuities. It offers buyers both buffers and floors; they can pick one or the other with different levels of protection or combine them. Most customers select a 20% buffer, protecting them from the first 20 percentage point decline in the underlying index. Should the S&P 500 decline 25%, for instance, their loss is only 5%. If the S&P 500 declines 20%, Athene Amplify owners who have chosen this buffer lose nothing.
Amplify owners can invest in the S&P 500, the smaller stock Russell 2000 index, or the international MSCI EAFE index – or all three together. For many prospective buyers, probably the most attractive alternative – available for a $10,000 minimum investment – invests in the S&P 500 for six years at an index participation rate of 135%, with a 20% buffer.
- Athene Amplify. This is a top-flight FIA for those who invest at least $75,000 in the S&P 500 MARC 5% index at a participation rate of 155%. MARC 5 is a low volatility index, one that invests in bonds and commodities, as well as stocks. These can realistically create an average annual return of 6% to 8% – less than many stock funds but still very good.
In the case of this particular S&P 500 index investment, however, it’s entirely possible to beat many traditional stock funds over its 10-year contract, even with the annuity’s 1% annual fee.
- Midland Summit Edge 5. This growth FIA offers a five-year contract, shorter than usual, and an advantage for people who want to maximize their investment flexibility. It offers an investment in the Fidelity Multifactor Yield Index, another low volatility index with a more creative strategy than most. It blends six stock indexes, including a dividend yield index, a value index, and a momentum index, with additional exposure to U.S. Treasury notes.
For investors who invest at least $100,000 and sign on to two-year crediting, the participation rate on the Fidelity MFY index is a whopping 160%.
Investors should appreciate that these annuities represent only a taste of what is out there. Given the inflationary environment, they should make an effort to explore these offerings and probably other players in the universe of fixed indexed and structured annuities to see which fits best with their investment preferences.
In so doing, they’re making a sound bet that a plain vanilla fixed annuity or a bank certificate of deposit is no longer good enough. The performance of the aforementioned annuities and others like them isn’t guaranteed. But the odds are extremely high that they will fare better than ho-hum investments.
For more information about the product mentioned in this article contact us here: