Before talking about when it is appropriate to use a certain financial tool, we should discuss what it is and how it works. Anthony writes in, “When should I use a fixed annuity for retirement?”
Thanks for writing, Anthony. See, a fixed annuity is a tool that one might consider for retirement when they want guaranteed payments growing or paying out at a certain rate. The term ‘fixed’ here means the account grows at a fixed interest rate and is therefore not subject to investment risk or fluctuations with the market.
As you might have guessed, this type of account is primarily useful for a person who is especially conservative (risk-averse) and cannot bear to see their hard-earned money fluctuate in their account.
So When Should You Use a Fixed Annuity?
For some people, the answer to this question may be “never.” It really depends on your time horizon for the investments in a given account and your tolerance to bear risk.
While annuities are a particularly useful tool for retirement planning, your investment objectives and financial goals will determine what tools you use.
Something to consider, however, is that utilizing any kind of fixed account will have its benefits and its drawbacks. For instance, it is not uncommon for fixed accounts to grow at a guaranteed rate of 2-3% a year. Considering this is guaranteed, many people may like the idea of a risk-free account that grows at many times what a savings account at a bank may grow at.
However, it is important to consider the opportunity costs with a fixed annuity. First, there is the fact that the fixed annuity may struggle to even keep up with inflation.With inflation averaging greater than 3% a year, a fixed account may not be the greatest option for accumulating wealth for a younger person with a long time horizon and the ability to withstand short-term market losses.
The second important factor to consider is that a diversified variable annuity account may average 6-7% annually. This kind of allocation would allow a person to absorb the 3% inflation rate and realize a real 3-4% increase in their money annually. And if the person is retired, it allows them to draw the 3-4% of their account value annually without drawing down the value, theoretically allowing the account to last in perpetuity.
It is important to consider what your objectives are and to discuss your goals with a professional before making any kind of long-term decisions like retirement planning.
But what do you think? What kind of tools have you utilized for retirement and how has it fared for you?
The information in this article does not constitute legal, financial, or tax advice. For help determining what tools to use in retirement, please contact a local retirement professional.