Pre Retirement Fixed Annuities
Fixed annuities are a cornerstone of retirement plans for millions of pre-retirees, and, as people climb out from underneath the rubble of their decimated 401(k) plans, they are being considered by millions more as way to lock in some stability during turbulent times. Even as fixed annuities rates fall, investors are looking to them to provide a safety offset to the riskier parts of their portfolios.
In the face of volatile markets and an uncertain economic future, investors are increasingly looking for more stability and predictability in their pre-retirement planning. Sound pre-retirement planning requires a careful consideration of all possible contingencies, and because it impossible to predict the future, there needs to be a safe and solid foundation that acts as a safety net if any of the other pieces of the plan begin to crumble.
Why Fixed Annuities
Fixed annuities are purchased primarily for their safety of principal and guarantees. Offered and backed by life insurance companies, fixed annuities have, historically, proven to be the most secure form of savings. Although banks have the backing of the FDIC (up to $100,000), it was the life insurance industry that came through to bail out the government and the private sector during the Great Depression. Life insurers with the highest financial ratings are considered to be rock solid in their ability to meet their obligations.
The current interest rates of fixed annuities, while low by historical standards, are highly competitive with other fixed yield investments such as CDs. Where a pre-retiree may be sacrificing the higher rate of return that could be earned from a stock mutual fund, the offset to the lower rate is the tax deferral of current interest earnings. The real value of the fixed annuity is that it provides stability and some predictability for the pre-retiree who desires to have a portion of his assets invested in the stock or bond markets.
There are other safe, fixed yield vehicles that can be considered and, as with any sound plan, having a mix of investments and savings vehicles is always prudent. For the pre-retiree who is most concerned with creating a stable and predictable income stream that will act as a floor, the fixed annuity has no peer. The guaranteed lifetime income that an annuity can generate is the ultimate protection against market risk. For more risk oriented investors, it acts as a stabilizer for a portfolio that is subject to unpredictable market swings.
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Fixed Annuities as Pre-Retirement Planning Vehicles
The portion of assets allocated between equities and fixed yield investment is going to depend on several factors such as time line, risk tolerance and the income need. The longer the time horizon, the more risk one could take and so a larger allocation towards equities might be warranted. As the time horizon grows shorter, the allocation towards more stable investments should increase.
Using fixed annuities in pre-retirement planning is a sound strategy when retirement begins to loom larger in your sights. The right timing to start investing in fixed annuities would be when there is still a 10 to 20 year time horizon and the investor is concerned about protecting his gains or limiting his losses. The ideal situation is when contributions to qualified plans have been maximized and sufficient funds are set aside in short term savings for liquidity purposes. At that time, an investor should consider allocating a percentage of assets to fixed annuities.
As the time horizon continues to shrink, the allocation to fixed annuities might increase as the desire for stability and predictability increases. Over the length of the time horizon, a laddering effect can be achieved whereby fixed annuities are added periodically. This advantage of this strategy is that the investor will be able to capture higher rates of return during times of increasing interest rates. Also, the individual fixed annuities can be held for different time periods so that they can be converted to income at different stages during the retirement years. The laddering of annuities this way provides more planning flexibility and increases the overall stability of the retiree’s income stream.
In today’s economic environment, pre-retirement planning requires greater attention to building the foundation, or safety net that provides the long term stability investors desire. With the safety of principal and income guarantees that pre-retirement fixed annuities provide, they should be considered as a key piece of the foundation.
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