Annuity payout yields have improved significantly over the past few years. Today, families can secure roughly 36% more lifetime income through an annuity than would have been possible three years ago. (UBS)

When approaching retirement, many families struggle with the transition from living off a stream of income to living off a limited pool of retirement savings. That's partially because the act of turning off your “income tap” dramatically increases two key risks:

  • Sequence of returns risk: This is the risk that your retirement spending—paired with poor market returns—will prematurely deplete your retirement assets.
  • Longevity risk: This is the risk that you will live longer than you had planned for, potentially requiring you to curtail your spending to reduce the risk of outliving your wealth.

Annuity income is one potential solution to these challenges.

When you purchase an annuity, you transfer the risk of outliving your savings to the insurance company. In return, they provide you with a guaranteed income stream, often for the rest of your life or until both you and your spouse have passed away. In the case of a lifetime annuity, you can continue to receive regular payments—providing increased financial security for your later retirement years—no matter how long you live.

Allocating a portion of your portfolio to annuities can allow you to lock in higher yields and secure a reliable stream of income that can last for the rest of your life. Similar to a bond, an annuity becomes more valuable if interest rates fall in the future (because it would be more expensive to replace this stream of income when interest rates are lower). By the same token, existing annuities may become less valuable if interest rates rise. Unlike a bond (or any other investment), a lifetime stream of annuity income also appreciates in value if your life expectancy increases due to good health and medical advances that improve longevity.

Here are three reasons for you to take a fresh look at annuities today:

1. Annuity yields have significantly improved
Annuity payout yields have improved significantly over the past few years. Today, families can secure roughly 36% more lifetime income through an annuity than would have been possible three years ago. Just like interest rates, annuity yields are higher than they have been in over a decade.

2. We anticipate lower portfolio returns
Stocks have been incredibly resilient to higher interest rates, and are now trading at some of the highest valuations in modern history. Many investors have learned the hard way that high valuations are a poor timing indicator—and certainly not a reason to exit stock market investments—but they have proven to be a headwind to future returns. As seen in Figure 2 of the report, the current price-to-earnings ratio for the S&P 500 is consistent with an average annualized price return of just 3.4% over the next 10 years.

3. It's expensive to manage longevity risk yourself

Especially given that life expectancies are generally rising over time, it's essential to have a plan in place to ensure you don't run out of money in your later years.

You could make sacrifices to try to “self-insure” your financial plan and improve resilience against the risk of poor returns and longevity risk. For example, you could delay retirement; reduce spending; or adopt a more conservative portfolio, prioritizing your lifestyle spending over the secondary goal to grow your wealth for needs that go beyond your own lifetime.

For many families, annuities are an option that can reduce the need to make these adjustments. Adding a modest allocation to annuities could help to increase the “safe spending rate” for a family in retirement by anywhere from 3% to 28%, with the greatest benefit going to families who are focused on targeting a higher probability of success in their financial plan ( See Figure 3 of the full report for more details).

Annuities are one effective tool for addressing the risk of outliving your savings, while also helping to provide increased financial security that allows you to enjoy your retirement years. Annuities may be especially valuable for families with a history of longevity, and for families that would like to increase their lifetime spending and the probability of success in their financial plan.

Speak with your financial advisor about annuities during your next conversation; they can help you to assess whether annuities are a good option for you and your family, and help you select the solution that best fits your needs. You should understand how the annuity works, and how each aspect affects the annuity’s potential return and contribution to your financial success.

See the full blog - Three reasons to seek annuity income , 20 September, 2023.