If you’re a retiree with an equity-heavy portfolio and have to make a withdrawal in a bear market during the early years of your retirement, you can dig such a hole that your savings will never recover.
Consider a retired couple with a $1 million portfolio. During their first year of retirement, the market drops 26% and they also make a $40,000 withdrawal, or 4% of their original principal, at the end of the year. Now their portfolio is down to $700,000. In year two, the market is up 4%, but because their second $40,000 withdrawal is at the end of the year, their portfolio will shrink to $688,000.
Unless there’s a big multi-year market rally soon — or they cut way back on their lifestyle by reducing their annual withdrawals — the portfolio could enter a death spiral. Even several years of good returns might not stem the decline, and eventually it can vanish.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Could Bad Luck Hurt Your Retirement?
Having to make early withdrawals during market downturns can decimate a portfolio. In contrast, if an investor enjoys strong returns during the early years, his or her portfolio will continue to grow despite withdrawals. It can withstand bear markets later on.
It’s just a matter of luck if a down market strikes early or late in your retirement. But you can’t rely on luck.
What’s the answer? Completely avoiding equities isn’t a good choice for most retirees, because that would preclude growth. Achieving the right balance between volatile equities and stable investments is a calculation that’s different for every retiree. The challenge is to get the best combination of yield and liquidity from the guaranteed portion of your retirement savings.
Having some cash is OK, but a large allocation isn’t wise. Yields on money market and savings accounts are running well behind the rate of inflation, even before taxes. Certificates of deposit pay more but are largely illiquid, and yields aren’t impressive these days, either.
Luckily, Annuities Can Take Luck Out of the Equation
If you are worried you may retire into a down market, guaranteed annuities offer a good solution for a portion of your retirement money. Several types can be deployed to meet virtually any retiree’s needs.
Various types of fixed annuities all guarantee your principal. But their characteristics are quite different.
Immediate income annuities
A retiree can choose an immediate annuity, which produces an immediate stream of income for either a set number of years or a lifetime. The monthly payments provide a cushion so that the owner won’t have to sell equities to raise cash in a down market. Meanwhile, the money remaining in the annuity is earning a much higher internal rate of return than cash equivalents.
Deferred fixed-rate annuities
Retirees can also invest in deferred fixed-rate annuities, which act much like a CD by providing a (usually higher) set rate of interest for a set period, plus tax deferral and some liquidity. These annuities often permit the owner to withdraw up to 10% annually without penalty. The accumulated interest portion of amounts withdrawn, however, is usually fully taxable.
Fixed-indexed annuities
Another good option is the fixed-indexed annuity, which is immune to stock-market downturns while offering a share of the gains when the market goes up. It gives you an opportunity to earn more interest than you can get from a fixed-rate annuity or a bank CD. You can shelter some of your money from market risk without locking in a lower interest rate.
Fixed indexed annuities, however, are less liquid than other investment alternatives, so it wouldn’t be a wise choice to put all of your retirement money into them. But they do help buffer a portfolio from severe ups and downs while offering potentially higher earnings than fixed-rate annuities over the long run. Many also offer lifetime income riders that can further reduce income uncertainty during retirement.
And the surrender terms of fixed-rate and fixed-indexed annuities can be laddered so that at least one is maturing each year and can be tapped if needed.
The Bottom Line
The stock market has been on a big upsurge for the last year. It’s natural to think the good times will keep rolling forever. But sooner or later they won’t. Maybe an uptick in inflation or a rise in historically low interest rates or an unforeseen crisis will cause stocks to tumble. To prevent the possibility that your retirement portfolio could enter a fatal tailspin, consider adding vehicles that are immune from stock-market downturns. Income annuities, fixed-rate annuities and fixed-indexed annuities can all be good choices.
How much should you allocate to annuities? It’s an individual calculation that must take into account all your savings, sources of income and risk tolerance.
A free quote comparison service with interest rates from dozens of insurers is available at https://www.annuityadvantage.com or by calling (800) 239-0356.
-
Amazon’s Try Before You Buy Is Ending — Here Are the Best Alternatives in 2025Amazon is ending its Try Before You Buy program on January 31, but you still have options. Discover the best alternatives, including clothing, eyewear and styling services.
-
Stock Market Today: Stocks Slip as Inflation Worries RiseConcerns over price pressures are growing ahead of next week's Fed meeting.
-
Secure Your Retirement Paycheck: The Power of Three BucketsPutting all of your nest egg in one basket is risky. Try putting it in three buckets for short-term, medium-term and long-term needs instead.
-
Five Reasons You Might Hate Your Insurance Company (and Why You Shouldn't)Stories about insurance companies letting down their customers are easy to come by, but there's another side to many of those stories.
-
How to Get Your Kids into Investing: A Family Project to TryTo teach your children about investing, put your money where your mouth is with this fun and potentially profitable exercise.
-
Risk On, Risk Off: The Mr. Miyagi Approach to Retirement PlanningThe first 10 years of retirement are some of the riskiest for your investments, but channeling your inner Karate Kid may help defend your funds against losses.
-
Opportunities and Challenges When You Inherit an IRANew SECURE 2.0 Act rules have kicked in to reshape distribution and taxes for inherited IRAs and retirement plans. Read on for strategies to help beneficiaries.
-
Getting Divorced? Beware of Hidden Tax Traps as You Divide AssetsDividing assets fairly in a divorce means looking beyond their current values and asking whether they'll create tax liabilities — or tax breaks — in the future.
-
All-You-Can-Eat Buffets: Can You Get Kicked Out for Eating Too Much?Don't plan on practicing your competitive-eating skills at an all-you-can-eat buffet. You can definitely get kicked out. Plus, don't be a jerk.
-
A Social Security Storm Is Gathering: Here's Your Safety PlanIf Social Security reserves are depleted by 2033, as predicted, future benefits could be cut by as much as 21%. Here’s how to weather the impending storm.
