You’ve been diligent about saving and investing throughout your career, and you feel confident your portfolio will produce enough lifetime income to fund a rewarding retirement.
But, will it really be that easy? Before you can celebrate your savings prowess, it’s important to consider what an unexpected market downturn could do to derail your plans.
As the bear market of 2008 to 2009 showed, a market downturn may deliver a nasty blow to your savings when you are just beginning retirement—a blow that might have lifestyle-changing implications. In fact, 60% of workers over 60 plan to seek another job after retiring from their present company, because of financial concerns.1 In addition, 11% of workers in this age bracket don't think they will ever be able to retire.2
Many investors nearing or just entering retirement may be too conservative in their investment portfolio, or too heavily invested in cash or cash-like instruments. While this protects savings, at least in nominal terms, it may hinder growth potential. The good news, however, is that there may be a way to consistently manage your portfolio to weather the volatility of the markets—via a “protected accumulation strategy.”
What is a protected accumulation strategy?
A protected accumulation strategy involves taking a portion of your savings—typically from a tax-deferred retirement account—just before or just as you retire, to purchase a deferred variable annuity with a guaranteed lifetime withdrawal benefit (GLWB). This approach effectively “locks in” some of your future retirement income today and protects it from a market drop.
What are the risks to which this strategy may be applied?
A protected accumulation strategy can help you shelter a portion of your retirement savings from three important risks—one you'll face throughout your investing lifetime, as well as two that are specific to investors in or approaching retirement.
1. Overreacting to short-term market events. Some of the emotional tendencies that define us as human beings tend to hamper our ability as long-term investors. We can be optimistic even when it's unwarranted, and we may overreact to news, exhibit loss aversion, experience regret, and copy the behavior of others in times of stress. Particularly in volatile markets, these tendencies may make long-term investment discipline and investment success even more difficult to achieve. As seen in the chart below, many investors have badly lagged the returns of equity and fixed income markets in the past decade.
2. Sequence-of-returns risk. This risk involves the actual order in which investment returns occur. Typically, negative returns earlier in retirement have a more severe impact on your portfolio than negative returns later in retirement. That’s because your portfolio’s value is reduced by both negative market performance and any withdrawals you take to fund your day-to-day expenses. This means that a smaller amount is left behind to experience any potential future growth. A sharp market downturn in the years leading up to retirement can have a similar impact and dramatically reduce the value of your investment portfolio and, thus, its ability to generate future income. In the chart below, two hypothetical portfolios, A and B, each begin with $100,000. Each investor aims to withdraw $7,000 per year, and it is assumed that both portfolios experience exactly the same compound annual returns over a 21-year period, only in inverse order, or “sequence.” Portfolio A has the bad luck of having a sequence of negative returns in its early years and is completely depleted by year 13. Portfolio B, in stark contrast, scores a few positive returns in its early years and ends up 21 years later with more than triple the amount of assets it started with.
3. Longevity risk. This is the risk that you outlive your retirement income sources. On average, a 65-year-old woman has another 23 years to live, while a man can expect to live another 20 years.3 But when it comes to retirement income planning, life expectancy figures can be seriously misleading. Half of the people born at any given time will outlive their own life expectancies. This means that most people ought to think hard about longevity risk—the real possibility of living 20, 30, or even 40 years past retirement age. Without planning, a longer-than-expected life could easily lead to a couple or individual outliving his or her savings. You may think you have an accurate read on your future retirement expenses, and confidence in your ability to fund them, but life can be unpredictable. So, it may be helpful to have a portion of your retirement income guaranteed for life.
How does a protected accumulation strategy help mitigate these risks?
Owning a deferred variable annuity with a GLWB enables you to transfer some of the key risks faced in retirement to the insurance company that issues the annuity. Among the potential benefits:
- An income stream you can’t outlive. The guarantees offered by GLWB products ensure income for the life of the annuity contract owner as well as the life of his/her spouse (if optional coverage is selected), even if the annuity's account balance is exhausted because of a combination of market performance and income withdrawals. These guarantees help to address longevity risk.
- A set level of guaranteed income. The income produced by this investment won’t go down if the market performs poorly. This feature helps protect against sequence-of-returns risk. Remember, you are insuring your income, not your account value, the latter of which will still fluctuate with changing market conditions.
- Upside growth potential. While you’re protecting your income needs against downside market risk, you may still benefit if the market goes up. Most GLWB products allow for potential increases in their guaranteed income in a rising market. These increases are also protected against future market declines. Once your income experiences an increase, it cannot be reduced because of any subsequent poor market performance.
- Additional investment confidence. "The use of a protected accumulation strategy may help conservative investors feel comfortable with a little more risk and, thus, the potential for higher longer-term returns into their portfolios," says Tim Gannon, vice president of product management at Fidelity Investments Life Insurance Company.
What type of investor might it be right for?
Gannon says two types of investors—each with a near-term need for lifetime retirement income—might benefit most from a protected accumulation strategy. The first type is an investor who is reluctantly "moving out of cash" and investing in the market for potential growth opportunities. These individuals, typically in their mid to late 50s, have most of their retirement savings in cash because they’re afraid of losing their money.
“The challenge is that a portfolio made up mostly of cash has limited growth potential and may be vulnerable to the risk of inflation,” says Gannon. "A protected accumulation strategy may give you a way to access the growth potential of riskier investments, with the confidence that you will receive a steady level of income no matter what the market does." By contrast, an income annuity may provide more income per dollar invested but does not have the upside potential of a GLWB.
The second type of investor who may benefit from a GLWB is one who is just entering retirement and is concerned about the market’s potential impact on his or her nest egg as he or she begins to take distributions from a portfolio. "Some recent retirees are worried that another bear market, like the one we saw in 2008, would completely disrupt their lifestyle," Gannon says. "This strategy can help protect a retirement portfolio from sequence of returns risk, and may reduce the chance that an investor might react emotionally to a market drop."
While a protected accumulation strategy does have potential advantages for some investors, it’s not a strategy for everyone. You should evaluate the costs associated with these types of guarantees in relation to your tolerance for uncertainty.
For some investors, it may be worth paying for guaranteed income and making sure you don’t have to delay retirement. But, other investors may not need this protection. If you already have sufficient guaranteed income—possibly a combination of Social Security, pension benefits, and income annuities—or you’ve got reliable income resources that could withstand a significant market downturn and still cover your living expenses, you probably don’t need a protected accumulation strategy.
It’s also important to remember that any guarantees are only as good as the insurance company that backs them. So, make sure that you choose an annuity that is offered by a company with a strong credit rating. Finally, although you can access your money in a GLWB annuity, if you need to withdraw more than the guaranteed income provided, do so with caution. In most cases, excess withdrawals and any withdrawals before age 59½ may reduce the guaranteed withdrawal benefit amount and may be subject to surrender fees.4
As you approach retirement, understanding your income needs and setting up reliable sources of income should be top of mind. You should start this process no later than five years before you plan to retire.
If you’ve planned well and saved carefully, you’re almost there. But if market volatility and its potential to derail your retirement plans are keeping you awake at night, you may want to consider the merits of a protected accumulation strategy.
Allowing an insurance company to manage certain risks may help you, in turn, feel more confident, knowing that no matter what the market does, or how long you live, the “check” will be in the mail.
- Learn more about MetLife Growth and Guaranteed IncomeSM, a deferred variable annuity with a guaranteed lifetime withdrawal benefit, offered through Fidelity.
- Visit the Fidelity Annuity Center.
- Read Viewpoints: “Smart strategies for retirement income.”
- Try our new Fidelity Income Strategy Evaluator®5 (login required) to test-drive different income-generating strategies to help you find one that’s right for you.
- Try our Retirement Income Planner.
Before investing, consider the investment objectives, risks, charges, and expenses of the fund or annuity and its investment options. Call or write for a free prospectus or, if available, a summary prospectus containing this information. Read it carefully.