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Will Adding A Fixed-Indexed Annuity To Your Portfolio Help Offset Inflation Risk?

Will Adding A Fixed-Indexed Annuity To Your Portfolio Help Offset Inflation Risk?

March 24, 2022

Fixed indexed annuities are one way you can buffer the negative effects of inflation and design a more efficient retirement blueprint.” Jerry Yu

Inflation and longevity are two of the most pernicious and impactful risks to a person’s retirement plan. Multiple studies indicate that the greatest fear of retiring Baby Boomers and Gen-Xers is running out of money when they retire. Not having enough money when you stop working is a rational concern, especially considering that demographers say by 2050, 25% of Americans will be 65 or older, 20 million of us will live beyond age 85, and nearly one million will reach 100.

These statistics starkly contrast those of 1950, when the average 65-year-old male could expect to live less than 13 years in retirement.

Complicating the situation of a rapidly-aging America is that over 70% of pre-retirees say they don’t believe they’ve saved enough to enjoy a decent retirement. Living too long, after all, compounds other ways in which your retirement savings are eaten away, such as higher inflation and taxes.

Conventional financial planning tells us that by withdrawing 4% of your egg each year, you should be able to make that money last until you no longer need it. For instance, if you had retirement savings of $300,000 and withdrew 4% annually, your average monthly income would be $1,000. That’s not enough to meet your basic needs, much less ensure a comfortable retirement.

Worse still, inflation will decimate your spending power so that $1,000 buys fewer goods and services. The bad news is that current inflation rates are much, much higher. For instance, a basket of groceries that cost $100 in 1990 cost approximately $207.88 in 2021. That’s a change of over 107%, assuming an annual inflation rate of 2.4%.

It’s evident that, even if you don’t consider the wealth-destroying effects of inflation, what you may have regarded as a reasonable amount of retirement savings is no longer viable, and a 4% spend rate over 30 years may not make sense.

Is an annuity a logical solution?

Conservative, inflation-adjusted retirement income solutions could solve many, if not most, of the problems encountered by retirees using traditional inflation-adjusted retirement income solutions.

In 2013, retirement researchers Dr. Wade Pfau, David Blanchett, and Dr. Michael Fink cast doubts on the “4% Rule.” Ground-breaking studies by Pfau and his colleagues suggest that the 4% Rule is not safe and could have a failure rate of as much as 57%.

Pfau plotted over 1,000 different portfolio allocations, projected the final value of each asset mix, and determined its probability to provide at least 30 years of retirement income needs. He theorized that the often-recommended 60% bonds 40% stocks mix is unlikely to produce a successful retirement. Pfau subsequently added a fixed indexed annuity (FIA) with a 30-year inflation-adjusted income rider to the mix in his follow-up paper.

Using worst-case scenario projections, Pfau’s results indicated that adding an annuity to a retirement matrix may outperform other product allocations, even at an assumed 4% inflation rate.

In other words, a properly-designed annuity can be a critical component in fighting the two-edged sword of inflation and longevity. While no one product will beat back inflation 100%, a fixed indexed annuity is still a powerful ally in safeguarding your financial fortress.

It’s crucial for anyone concerned about running out of money in retirement to sit down with a qualified retirement income specialist and do the math to see if adding an annuity makes sense in their situation.