The market can influence your decision of when to retire. Learn how to help protect your nest egg, including the potential role of annuities in retirement.
You’ve worked hard almost all your life, saving along the way for your retirement, which is now upon you. Gone are the days of asking yourself, “When can I retire?” You’re finally ready to transition to a new lifestyle of relaxing and enjoying the things you’ve long dreamt of doing when you finally have the time: traveling, reconnecting with old friends and spending more time with the grandkids, to name a few.
But how realistic is this dream of retirement living if the market declines? What can you do to protect yourself from running out of money in retirement? For many, such questions have taken on new urgency amid rising inflation, market volatility and a wave of accelerated retirements1 during the pandemic. Fortunately, there are ways to help you prepare for the market’s unknowns as you approach retirement.
The closer to retirement, the more vulnerable you are to adverse market conditions. That’s because you have less time to recover from such setbacks. One of the greatest risks for retirees is what’s called “sequence risk,” or sequence-of-returns risk. This refers to the risk of locking in potential losses during times of poor performance right when you need to withdraw funds from your retirement portfolio, which can be especially hard to recover from early in retirement.
“A bad sequence of returns in your portfolio could force you into having to spend less in retirement to avoid depleting your nest egg too quickly,” explains Joe Toledano, Managing Director, Head of Insured Solutions, Morgan Stanley Wealth Management.
Here’s one such scenario: Let’s say a retiree with a $1 million portfolio plans to withdraw 4%, or $40,000, in her first year of retirement. If her portfolio suddenly declines 30% to a value of $700,000, that original $40,000 withdrawal now accounts for 5.7% of the portfolio’s value. Such a higher rate of withdrawal may not be sustainable long term without a rapid recovery in portfolio value. What’s more, withdrawing funds during this hypothetical bear market lowers her portfolio’s base of assets, increasing the returns that would be required for it to recover.
For most Americans, gone are the days of a traditional pension plan that provides a steady, guaranteed income stream in retirement. Today, only 15% of individuals in the private sector have access to such defined-benefit pension plans, notes Toledano, pointing to data from the U.S. Department of Labor. 2
Along with concerns over low bond yields, this makes it even harder to solve for retirees’ income needs. “Traditionally, bond yields provided some sense of security, but even with interest rates rising, current rates may not be enough to support the income that clients need to cover their expenses in retirement,” adds Carmine Mazzeo, Executive Director, Insured Solutions, Morgan Stanley Wealth Management.
Annuities can help mitigate sequence risk by providing a reliable source of income that can reduce—and, in some cases, may even eliminate—the need to sell portfolio assets with high return potential at a moment when asset prices have fallen precipitously. Annuities with guaranteed income-protection benefits provide a set level of income for the rest of your life, much like a traditional pension in that respect. By adding such annuities to your portfolio, you may potentially reduce the risks that poor judgment, declining markets or a longer-than-expected life expectancy will jeopardize your ability to live comfortably in retirement.
Annuities come in many forms, including variable and fixed indexed, both of which provide lifetime income protection. A variable annuity’s value is based on the performance of an underlying portfolio of professionally managed investment options that the owner selects. In contrast, a fixed indexed annuity’s returns are benchmarked to the performance of an index, such as the S&P 500, with floors and caps that protect the investor’s principal but that may also limit potential gains.
“Variable annuities can be an effective way to reduce longevity risk for those wishing to retain equity market exposure, while fixed indexed annuities can have a strong risk-reduction effect within a retirement income plan when substituted for bonds”, notes Dan Hunt, Morgan Stanley Wealth Management Senior Investment Strategist. “Both can successfully reduce risk in a retirement plan because their payout rates are typically higher than the yields on traditional investments and they remain viable regardless of one’s longevity,” he says.
With so much uncertainty and so many investment solutions, retirees shouldn’t go it alone. Your Morgan Stanley Financial Advisor can help you not only evaluate and secure the appropriate annuity options from the most trusted and highest-rated issuers, but also develop investment and systematic withdrawal strategies based on your personal time horizon.
Morgan Stanley takes a modern approach to wealth management, where investment decisions are based on each client’s goals and risk tolerance. The firm’s risk management tools help our Financial Advisors customize plans for each individual, based on your goals (such as when to retire) and the right investments to help you achieve them.
Talk to your Morgan Stanley Financial Advisor today about annuities and other options that can be an integral part of your retirement planning.