Are Annuities Recession-Proof? A Closer Look

Some experts predict a recession will hit the U.S. economy within 18 months due to converging global and domestic forces.

In particular, the U.S. job market unexpectedly contracted in early August, triggering a sharp market correction. In July, investors were concerned that the Federal Reserve might keep interest rates elevated longer than expected, given slower job growth and higher unemployment rates. It sent shockwaves through the market when this abrupt sentiment shift occurred.

By August 5th, the S&P 500 had plummeted by over 8%, while the NASDAQ Composite had dropped by an even steeper 13%. These domestic challenges caused global monetary policies to diverge, further causing the market’s volatility.

As a possible recession looms, retirement planning becomes even more unsettling. After all, when the economy slumps, many people question the safety of their hard-earned savings. However, annuities have attracted attention because they’re a good investment during turbulent times.

But are they truly safe in a recession? Well, let’s delve into the details.

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Annuities: A Retirement Income Option

For those unfamiliar with annuities, they are financial products used for retirement planning. Unlike stocks and bonds, annuities are contracts issued by life insurance companies. Because of this, insurance agents typically sell them instead of stockbrokers.

When you retire, annuities can provide you with a steady stream of income based on your savings. Depending on the type of annuity, you can begin receiving payments once you reach the age of 59 ½.

Depending on your preferences, these payments can be scheduled for a specific period of time, like five or ten years, or they can last for the rest of your life. Regardless, this can create a form of guaranteed retirement income for you.

Because of this consistency and steady income, they are very popular with retirees. Similarly to pensions, annuities offer predictable monthly payments that can provide financial stability. So, by converting your annuity to a guaranteed income stream, you can establish a sound financial foundation for retirement. As a result, you will be able to manage market volatility and maintain your lifestyle even during tough economic times.

When it comes to annuities, there are three types;

Fixed annuities. Investing in these provides predictable returns regardless of market fluctuations, as the interest rate is guaranteed for a certain period of time.
Variable annuities. Linked to investment accounts, these annuities fluctuate based on their performance.
Fixed-indexed annuities. With these hybrids, you get a minimum guaranteed interest rate and shares on the upside of the market index.

Annuities and Economic Downturns

Annuities’ safety depends mainly on their type in a recession.

Fixed Annuities: Your Recession-Proof Fortress.

Whether the economy is doing well or not, fixed annuities are dependable guardians of your savings. Why? Despite fluctuations in the market, their guaranteed return remains constant. When economic downturns can result in considerable losses for investment portfolios, this predictability is a significant advantage.

Even though fixed annuities may not offer as good returns as some investments in booming economies, their consistency during recessions is invaluable. As a result, they offer a sense of security when other income sources become less reliable.

If you want to recession-proof your retirement savings, though, two types of fixed annuities may appeal to you in particular. However, you should keep in mind that the best annuity for you depends on your ability to pay into the contract and how often you can do so.

Single-Premium Fixed Annuity

An annuity with a single premium is a financial product funded by a lump sum payment. It provides a steady income stream and offers a guaranteed rate of return.

In general, these annuities start paying out almost immediately, making them a reliable source of income for retirees.
Investing in fixed-rate bonds protects you from market downturns as your money earns a fixed interest rate.

Often, these annuities are used to roll over old 401(k) s or IRAs to secure retirement income.

Deferred Fixed Annuity

Deferred fixed annuities offer the same fixed rate of return as their single-premium counterparts. Rather than withdrawing money immediately, you allow it to grow over time before withdrawing it.

The accumulation phase. Your investment can grow tax-deferred during this period.
Ideal for younger savers. Deferred annuities can be a good way to save for retirement if you do not have a large lump sum. As such, these may be a better option for younger investors.

With a deferred annuity, you can save for the future while getting a guaranteed return.

Variable Annuities: A Risky Bet in a Recession

In addition to potentially earning higher returns, variable annuities are often marketed as a means of achieving such returns. It comes with a significant caveat, however: they’re linked to the stock market. As a result, their value can fluctuate widely, especially during a recession. They could likely offer some upside potential when markets are booming, but they can be risky if things are not going well.

It’s also important to keep in mind that variable annuities often have hefty fees. Over time, these fees can reduce your returns. Investing directly in the stock market can save you these unnecessary expenses if you’re considering it.

Variable annuities sometimes have volatility-management features, but these features often have limitations. Additionally, many people desire to receive income from their annuities while they are still alive, not just death benefits. Investing in a fixed annuity may be a better option if you’re more concerned about security than high returns.

Fixed-Indexed Annuities: A Middle Ground

Fixed-indexed annuities fall somewhere in the middle.

With fixed-indexed annuities (FIAs), interest rates rise and fall along with a market index, such as the Nasdaq or S&P 500. Therefore, when stock prices decline, so do FIA returns during economic downturns.

However, FIAs have a safety net known as a “loss floor,” which is typically set at 0%. As a result, your account value won’t decrease despite poor market performance. Although this protects your principal, it also limits the earnings you can make during recessions. When the economy is weak, FIAs may offer modest returns.

Annuities provide a guaranteed minimum return and have upside potential as well. With a guaranteed minimum rate, a recession protects the downside but limits the upside.

Interest Rates: A Key Factor

Annuities, particularly fixed annuities, are highly dependent on interest rates. In times of rising interest rates, fixed annuities tend to pay out more, making them more attractive to investors. Alternatively, annuity payouts may be less attractive when interest rates are low.

In other words, when you purchase your annuity can significantly influence its performance. Buying an annuity at a low interest rate may result in you earning less than if you bought it at a higher rate.

The Biggest Risk: Choosing the Wrong Annuity

Investing in annuities comes with a number of risks, including poorly performing contracts. In this case, you’ll likely choose an annuity with excessive fees or one unsuitable for your needs.

You’ll want to minimize this risk by working with a qualified financial advisor who can help you understand your options and select the right annuity for you.

Conclusion

While no investment is entirely immune from economic cycles, fixed annuities have a strong degree of protection during recessions. As a retirement planning tool, they provide a stable income stream along with guaranteed rates of return.

When making annuity decisions, consider your overall financial goals, risk tolerance, and time horizon. You should seek advice from a financial advisor to determine the best annuity for you.

It is also important to remember that diversification is one of the best ways to manage risks. Balance your annuities with other investments to create a well-rounded retirement strategy.

Understanding annuities’ characteristics will help you make informed financial decisions despite uncertain economic times.

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