In part one of this series, we discussed how a prolonged downturn in the market during the fragile decade can derail withdrawal plans. The conventional approach to managing through market declines and loss years is to take the long view, keep investing and rely on long-term averages to eventually help the portfolio recover.

This approach can work well when you are younger and have salary income and decades to ride out the storm before taking withdrawals. For those of us near or in the fragile decade, the long view may not be the optimal course of action, or worse, it could be downright devastating, as we saw in part one.

As you approach your retirement date, you should have a more accurately defined and refined list of spending needs. This is when your investment strategy can (and likely will) diverge from the accumulation stage.

Balancing risk with returns

A lot of the investing concepts we discuss for the accumulation stage (and are put forth by financial advisers) are grounded in Modern Portfolio Theory (MPT), which seeks to optimize market returns and risk by asset class. Simply stated, as you invest for the long term, get as much of a return as you can, given your level of risk tolerance.

Harry Markowitz introduced the world to MPT in 1952, and his principles have influenced generations of financial thinking. In 1990, Markowitz shared the Nobel Memorial Prize in Economic Sciences for his efforts around MPT.

Finding this optimal balance of return and risk is what Markowitz describes as investing along the efficient frontier. MPT has been successfully used for decades by institutions such as endowments, pension plans and large trust funds, etc. The traditional approach to retirement planning has taken the principles of MPT and adapted them to individual investors.

But here’s the rub: Large institutions, like endowments, have an infinite time horizon without a fragile decade. Institutions are effectively in a perpetual accumulation stage. They do not need to plan for and manage through a significant and finite withdrawal stage, but you do.

“If you want something you’ve never had, you must be willing to do something you’ve never done.” — Thomas Jefferson

Enter goals-based planning. With origins going back decades, goals-based planning gained in popularity after the 2008-2009 financial crisis. It seeks to refocus our goals away from obtaining abstract market return rates and toward meeting specific personal goals (e.g., our monthly spending needs).

Making risk more tangible

As such, we should similarly reframe our risk profile, moving away from focusing on the volatility of market prices. We should describe our risk in a much more personal way: Our principal risk is the chance that we fall short of our spending goals.

A goals-based approach to planning can help make the risk more tangible. We take measured, personally defined risks and don’t endlessly ponder esoteric risks (such as standard deviation, alpha, beta, R-squared and the Sharpe ratio). Goals-based planning is focused on optimizing a limited pool of financial assets by matching assets and income with future liabilities and expenses (i.e., future spending needs).

If, for example, you can meet all your cash flow needs with a 5% return, then why take on a greater risk of loss to try to achieve a higher return? Why risk losing what you have and need to chase what you don’t have and don’t need?

Your goals, not just your risk tolerance, should drive investing decisions. During the withdrawal stage, income and capital preservation become much more important than stretching for outsized returns.

Under the umbrella of goals-based planning, the idea of a safety-first strategy has evolved. Briefly, a goals-based safety-first strategy looks at your spending goals in two broad buckets. The first, the safe bucket, seeks to cover your basic financial needs (e.g., housing, food, health care, emergency fund, etc.) with assets invested with as little risk as possible (the safety-first component).

Safety-first investments to consider

To start, you might think of safety-first investments such as bank CDs, money market funds, short-duration government bonds and bond ladders, etc. But don’t lose sight of other financial resources you might have beyond cash and bonds that could also provide safety-first withdrawals. For example, Social Security, a pension, rental income from real estate, income annuities and insurance products. The key is to build a stream of income that will cover your basic needs regardless of a declining stock market.

Once this safety-first basket is secure, you can then put the remainder of your portfolio in the second or aggressive bucket, to cover discretionary spending (wants), which can be invested as aggressively (or conservatively) as you see fit. When your basic needs are met, you can decide how much risk you want to take to achieve your aspirational wants — those items that would be nice to have (more frequent vacations, etc.), but in a falling stock market, you could do without.

In part three of this series, we’ll offer up some specific ideas for mitigating the impact of sequence of returns risk and protecting the retirement cash flow you have diligently worked to achieve.

As always, invest often and wisely. Thank you for reading.

This content is for informational purposes only. It is not intended to be, nor should it be construed as, legal, tax, investment, financial or other advice.

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Here, we look at how higher interest rates impact different types of annuities. 

Fixed index annuities

Fixed annuities are paying higher guaranteed rates to match current market conditions. Fixed index annuities have also become a better deal. Many now offer higher possible caps for your returns as insurers are earning more. 

The interest rate environment doesn’t matter as much for variable annuities, as the returns depend on the performance of the mutual funds they invest in rather than rates.

Initial bonuses

Many annuities also pay initial bonuses as a percentage of your deposit that can be worth 10% or more. 

“If someone bought an annuity years ago when rates were low, it could make sense to break a contract to get the better rates. A bonus would help offset the surrender charge,” says Mindy Oglesby, a certified financial planner and CEO of Oglesby Wealth Strategies in Watkinsville, Ga.

How old is the annuity holder?

High interest rates could help you earn more if you’re looking for income, but it depends on your age. “It matters much more the younger you are,” says David Blanchett, head of retirement research for PGIM DC Solutions, the investment management division of Prudential. 

If you’re 55, the amount of your payout is based on the insurer investing the money for the long term. High interest rates can help you lock in higher lifetime income. If you’re 85, high interest rates don’t matter as much. “At this point, payouts are mainly based on life expectancy.”

The possibility of rate cuts 

Interest rates could fall later this year, although higher-than-expected inflation in early 2024 may delay rate cuts from the Federal Reserve. The possibility of declining rates provides extra incentive to purchase some types of annuities sooner than later. 

But before you pull the trigger, make sure an annuity is appropriate for your long-term financial goals. If you cancel an annuity early, surrender charges could wipe out any benefit you gain by purchasing it when interest rates are high. 

Note: This item first appeared in Kiplinger Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.

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“An annuity is like a personal pension,” says David Blanchett, head of retirement research for PGIM DC Solutions, the investment management division of Prudential. You transfer part of your savings to an insurance company, which then turns that money into future income payments. You can set up an annuity that provides guaranteed income for the rest of your life, like a pension. “No matter how long you live or what happens in the market, you’ll get some benefit.”  

Having a paycheck you cannot outlive makes retirement a lot less stressful. Studies show that retirees with at least some annuitized income are happier, more satisfied and less likely to be depressed than those without. Creating this extra paycheck for life also takes out some of the work of budgeting and investing your money, especially later in retirement, when you may begin to experience cognitive decline. “It’s like an easy button for turning wealth into income,” says Blanchett.

That said, it’s essential to research annuities carefully before using one. They are long-term investments. If you buy an annuity, getting your money back is costly and sometimes impossible. There are also many types to choose from. If you are considering an annuity, here’s what to know about when these contracts make sense and their pros and cons.

Options for growth and income

Annuities can both increase your savings and provide future retirement income. If you aren’t ready to turn on the income spigot yet, you can use a deferred annuity to earn a return on your money. There are a few types of deferred annuities. 

A fixed annuity pays a guaranteed interest rate on your savings. “It’s like a bank certificate of deposit on steroids,” says Mindy Oglesby, a certified financial planner and CEO of Oglesby Wealth Strategies in Watkinsville, Ga. For example, you might find a fixed annuity with a 6% guaranteed interest rate for five years.

A variable annuity lets you invest your balance in mutual funds. The money you invest in a fixed index annuity increases based on the performance of a market index, such as the S&P 500. However, there are limits on your gains and losses. For example, a fixed index annuity might dictate that you won’t lose money during down markets but cap your gains at 8% per year, no matter how high the index goes.

Each type of deferred annuity lasts for a scheduled number of years that you pick. At the end, you can renew to another deferred annuity, cash out your money or convert the balance into income.

Immediate income annuities. If you’re ready to get paid from an annuity, you have several ways to do so. An income annuity is the simplest version. You transfer part of your savings and immediately start collecting income based on your deposit. 

You can set up payments for a set period, such as 10 years. Payments continue to your named beneficiary if you pass away before the period ends. After that, payments stop. You can also set up payments that last for your entire life. It’s possible to choose guaranteed payments for as long as both you and your spouse live.

For example, say a 65-year-old man buys an income annuity for $200,000. He’d receive $1,271 per month guaranteed for his life, according to Charles Schwab’s online annuity calculator. If he’s married to a 60-year-old spouse, they could get a joint-life annuity paying $1,043 per month for as long as one of them is alive. 

You could set up a lifetime income annuity with a minimum number of guaranteed payments in case you pass away early. “If someone gets hit by a bus the day after purchase, their heirs will get the money. It protects against dying early,” says David Lau, founder of DPL Financial Partners, an online platform for buying annuities.

Guaranteed income riders. Another option is to set up a minimum guaranteed income rider on a variable or fixed index annuity. With these contracts, your money is invested and grows as usual. Once you’re ready to start payments, your income is based on your contract value at that point. For example, if you start payments with $200,000 in a variable annuity, the insurer may promise lifetime income of 5% of that balance, or $10,000 per year.

The money you put in stays invested, and ideally your contract balance will increase. But if withdrawals and poor investment performance deplete the entire value, you’ll continue to get the lifetime income ($10,000 a year in the previous example). You could take a lump-sum withdrawal from your balance at any point. Doing so would reduce your future guaranteed income, but it gives you liquidity in a pinch. If you pass away with a positive balance, it goes to your heirs. 

Adding the guaranteed income rider on an annuity costs extra, and that lowers your long-term return. A common fee is 1% a year off your investment return. The guaranteed income payouts are also lower compared with putting the same amount in an immediate income annuity. 

Deferred income annuities. If you aren’t ready to retire just yet, you could buy an income annuity that begins payments in the future. The longer you wait, the larger your future payments. A deferred income annuity can also support the final stretch of your retirement.

“You could buy an annuity with a deeply deferred payment date, like age 82 or later,” says Jim Szostek, vice president of retirement security at the American Council of Life Insurers (ACLI). “You know you will still have income at the tail end of retirement.” Because roughly one-third of 65-year-olds will reach age 90, this later-in-life income could be worth considering.

If you have money in a traditional, tax-deferred 401(k) or IRA, the government requires you to start making withdrawals at age 73. However, you could use funds from those accounts to set up a qualified longevity annuity contract (QLAC), which would allow you to push back withdrawals to age 85 for more tax-deferred growth.

The benefits of annuities

As with any investment, annuities come with pros and cons. Here are some good reasons to use these contracts.

Guaranteed retirement income. The guaranteed income that an annuity creates provides valuable peace of mind in retirement, says Szostek. “It keeps people from running out of money and allows them to spend the rest of their savings more freely. Otherwise, you might be too conservative and deny some of the pleasures you could have had in retirement.”

Stability from risk pooling. Insurance companies can generally afford to pay out higher income than most people could safely draw from their portfolios because of risk pooling and the law of large numbers, says Blanchett from PGIM DC Solutions. “If I plan on my own, I have to be more careful. There’s a 50% chance I’ll live longer than my life expectancy.” 

By combining resources from many people, insurers can wait out market swings and cover the payouts for those who have exceptionally long life spans. People who live a long time also benefit from mortality credits: They get extra money from the annuity pool from people who passed away earlier. 

Safe returns. Fixed and fixed index annuities can offer growth while preventing market losses in the final few years before retirement. You can avoid a major loss at this point, when you don’t have much time to recover. “The downside protection is useful from a risk-management point of view,” says Lau, the founder of online annuity platform DPL Financial Partners. “If your portfolio is negatively impacted in the last stretch, it will hit your retirement hard.”

Tax-deferred growth. You don’t owe taxes on investment gains as long as they stay in the annuity. If you buy an annuity using after-tax money from your savings, it grows tax-deferred, and you get those deposits back tax-free when you withdraw them or receive the money as income payments; you pay income tax on investment earnings. “For someone who maxes out their 401(k) and other retirement plans, an annuity offers another way to get tax-deferred growth,” says Oglesby, the CFP from Georgia. 

If you put pretax funds from a retirement plan, such as a traditional IRA, into an annuity, taxes continue to be deferred until you withdraw the money or start income payments. It is also becoming more common for workplace retirement plans, such as 401(k)s, to offer annuities because the SECURE Act of 2019 removed legal barriers for the plans to provide this option. When you cash out or receive income, you pay income tax on the entire amount.  

Extra rider benefits. You can buy riders to create other benefits for your annuity. One option is to add a long-term-care rider. If you need long-term care in a nursing home while collecting annuity income, the annuity increases your payment to help cover the costs. You could also buy a rider so that an annuity leaves a larger death benefit to your heirs. 

The drawbacks of annuities 

Surrender charges and taxes. When you buy a deferred annuity for growth, you agree to a long-term contract of several years. You pick the length when you sign up. If you cancel or take a lump-sum withdrawal before the period expires, the annuity company will likely deduct a surrender charge.

For example, the company might deduct 7% from the amount you take out. Surrender charges gradually decrease the longer you own the annuity — the charge may, for instance, fall by one percentage point per year before disappearing after seven years. Some annuities allow limited withdrawals without the surrender charge, such as taking out 10% of your balance per year. 

Early-withdrawal tax penalty. As retirement products, annuities lock up your money until you turn 59½, warns Lau. If you cancel an annuity or take a lump-sum withdrawal before you reach that age, the IRS charges income tax plus a 10% early-withdrawal penalty on your gains. And if you made pretax contributions, you’ll pay tax and the 10% penalty on withdrawals of the contributions, too. 

If you take lump-sum withdrawals, annuities require you to take out the taxable portion first before any after-tax deposits. The 10% penalty doesn’t apply if you convert your annuity into future income payments with the insurance company. You can start that at any age.

Limited liquidity. Buying an income annuity takes money out of your portfolio. “Removing liquidity is dangerous. You could run into a health problem, or your kids might have an emergency,” says Randy Kurtz, a CFP with Upper Left Wealth Management in Tampa.

As noted, there are ways to create guaranteed lifetime annuity income while keeping some access to your money. Still, you don’t have the same flexible access to your cash that you would by keeping it all in your investment portfolio.

High fees. Generally, the more complex an annuity is, the more it costs. Basic fixed and income annuities have few or no fees. Variable annuities with many riders can be expensive. “I once saw a variable annuity deducting more than 4% a year from the investment return,” says Kurtz. Make sure you understand exactly what’s being taken out of your earnings each year for the contract.

Inflation. Most income annuities pay out the same monthly amount the entire time, and inflation can chip away at your spending power. You could set up your annuity with a rider for cost-of-living adjustments. Your payments then increase over time—by 2% annually, for instance. In exchange, your starting income is lower. Another option is to use variable payments that depend on the market. You get more income in good years and less in bad, with a higher expected return.

Is an annuity a good choice for you?

As you weigh whether an annuity makes sense, think through these factors.

Other guaranteed retirement income. Start by looking at your expected, fixed monthly retirement expenses, recommends Szostek from the ACLI. Think of bills for your rent or mortgage, utilities, insurance, food, car, and other costs that will come up month after month.

Ideally, you should have enough guaranteed income to cover these ongoing expenses so that you don’t have to worry about them. If you expect $4,000 a month in fixed expenses and get $2,000 a month from Social Security, you could use an annuity to cover the remaining $2,000. You would then invest the rest of your savings to cover variable expenses that you can skip during a market downturn, such as travel and home renovations.

However, if all of your fixed costs are covered by Social Security and/or a pension, you might not need an annuity. Although you can start Social Security at age 62, each year you wait until age 70 increases your benefit. If you need income while delaying your application for Social Security benefits until age 70, you could use an annuity to get through that stretch. 

Once you start Social Security, you get cost-of-living adjustments to help keep pace with inflation. This makes Social Security an even better deal than an annuity, says Blanchett. “Many Americans can get all the guaranteed income they need just by delaying Social Security until age 70.”  

Life expectancy. You should also consider your health and life expectancy based on family history. If you’re in excellent health and have a good chance of living longer than average, an annuity with guaranteed lifetime income could be a good deal. On the other hand, someone with preexisting conditions who may have a shorter retirement might prefer to keep access to all their cash and spend it while they can.

Investment risk tolerance. Annuities are often most suitable for risk-averse people, “I recommend them to clients who don’t want to deal with the stock market ups and downs,” says Oglesby.

On the other hand, if you’re comfortable investing and managing risk, you might get a better long-term return and generate more income on your own, especially at a time when you can lock in 30-year Treasury bonds paying more than 4.5% a year in guaranteed interest, says Kurtz. “I recommend putting two to five years of spending needs in bonds, with the rest invested for market returns.” That way, you don’t have to sell off your stocks during a downturn.

If you think an annuity is a good fit for you, avoid putting all of your savings in one. Contribute only up to about 20% to 40% of your portfolio so you still have money that’s easily accessible and that you can invest in the stock market for growth.  “An annuity is insurance,” says Blanchett. “You don’t buy insurance to make money but to mitigate a risk. In this case, the risks are longevity and outliving your savings.”

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Then you start to think about all that has happened in the world — and how your objectives may have changed — since you set up your “plan.” The holes probably loom large in your imagination, but there will be improvements that you can take advantage of, too, if you recognize them.

For one thing, the longer you live in your house, the more equity you have, barring emergencies. Current interest rates and inflation may seem alarming, but higher interest rates can also bring you more income from annuities. And keeping taxes lower in retirement is more likely when you employ the tools now at your disposal just because you’ve lived a little longer and saved a little bit more.

Designing the plan that best fits you

Start by thinking about your own wants and needs. There’s no reason to be intimidated. You know your objectives better than anyone. You also know your budget requirements, and also what your kids may need, and even whether you’re an “age-in-place” person.

Decide what’s most important to you. It could be tax reduction, the amount of guaranteed income or having liquid funds to pay for long-term care, a critical health crisis or another kind of emergency. You probably have in mind a number for starting income and whether you plan to leave a legacy to heirs. And perhaps you want to put off taking Social Security benefits as long as possible, or ensure continuity of income to your spouse. Finally, factor in your thoughts about the future of inflation and stock market performance.

The challenge is how to go from your current plan to one that meets your new thinking. Here’s a way to think about the process while at the same understanding more clearly what each step brings.

Starting with a traditional investment-only plan

Set out below is how a typical asset-focused plan might look. The plan is generating dividends and interest and using IRA withdrawals for current income and protects itself against large market losses by a low 30% allocation to stocks.

As you rethink your objectives, your new plan will begin to unfold. The order of steps above represents one set of personal objectives and just one way to implement that new plan.

Adding income annuities to the mix

In considering the next stage, you will see that income annuities can provide more income, lower your taxes and reduce your income risk.

For instance, IRS rules allow you to take $200,000 from a rollover IRA account and purchase a QLAC, a type of deferred income annuity that is designed to begin producing payments as late as age 85.

Income for today comes with a single-premium immediate annuity (SPIA), purchased with already-taxed savings to create a larger income stream without large additional taxes.

This is a logical and straightforward decision, replacing some of the fixed-income investments with income annuities.

Adding HECM to provide more income and liquidity

The next step: Add a home equity conversion mortgage, or HECM, to provide more income and, most important, a line of credit that grows over time. Under IRS rules, both sources of cash are considered loans and are not subject to federal income tax. If you end up needing money to pay for health care costs not covered by insurance, your HECM line of credit should cover it or give you a good start.

Under HomeEquity2Income, or H2I, HECM and QLAC are combined so that QLAC payments will pay for the HECM interest as well as provide income after age 85.

Now we have a plan that has attractive income and liquidity.

Final adjustments to balance market risk

Final step: With these two new asset classes in place, consider what level of risk you might assume in your split between fixed income and stock investment portfolios. With your greater security of income and lower taxes, you can increase the allocation of the stock portfolio in personal savings to high-dividend stocks, providing yet more income. The growth portfolio in your rollover IRA will provide potential for higher withdrawals.

Note that while this plan is apparently more aggressive, there is a lower-percentage allocation to stocks.

Other steps to consider

When you have more spendable money, you have additional options. You may decide to allocate a portion of your IRA withdrawals to a Roth IRA for tax purposes. If you have grandkids, a 529 plan awaits for funding college educations. You will have other options, too.

When you’re done, the new plan may still have some elements of the old plan, but the updates will allow you to more easily meet your goals for retirement income, liquidity, legacy and taxes.

Get started at Go2Income

Take the first step with a visit to Go2Income and start building a plan that considers income, taxes and long-term goals. The exercise is flexible, and when you have questions, schedule time with a Go2Specialist, who can answer all your questions.

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The thing about selecting an annuity is that everyone is seeking something different from adding an annuity to their portfolio. So there isn’t a one-size-fits-all solution.

Picking an annuity is sort of like buying a car — all car buyers are looking for a vehicle to get them from point A to point B. But there are so many considerations beyond that. Some factors are basic, like how many passengers it needs to transport. Others are more specific, like if you want heated seats or a sunroof. Annuities are similar in a way — they can help you get to and through retirement with varying features.

Roles of annuities

Before you start looking at different products, you’ll want to think about what role you want an annuity to play in your portfolio. The way you want this asset to complement the rest of your financial portfolio can help in determining what kind of annuity may be appropriate and then which specific product may work well for you.

One common reason to add an annuity to a portfolio is to guarantee a portion of your retirement income. Still, there are other roles for an annuity to play. Depending on your life stage and how close you are to retirement, the role you want an annuity to play in your portfolio may differ. You may want a level of protection for some of your assets in an annuity so you can take greater risk elsewhere in your portfolio. You may be seeking ways to manage taxes or other risks to your retirement. You want to understand why you’re adding an annuity to your portfolio so you can pick one that can help address your needs.

Three types of annuities

Let’s go through some of the types of annuities and some considerations as you look at products. To be sure, you’ll want the guidance of a financial professional and a qualified tax adviser for any tax-related concerns before making a decision.

The main categories of annuities to consider are traditional variable annuities, registered index linked annuities (RILAs) and fixed annuities.

A traditional variable annuity offers growth potential through a range of investment options. The value of the annuity will depend on the performance of the investment options selected — the underlying investments may include equity, bonds or cash equivalents. This financial vehicle is designed to help with retirement and other long-term goals. Variable annuities offer guaranteed lifetime income, a death benefit (generally available during the accumulation phase) and tax-deferred growth potential.

A RILA straddles a level of protection and growth potential with gains or losses based on how a selected benchmark index performs over time. So, typically there is some protection when the selected index goes down and gains (generally limited by a cap or subject to a participation rate) when the selected index increases. RILAs offer the ability to participate in the growth of an index — although growth is based on the performance of an index, you are not investing directly in an index. There are various options for which index your product tracks.

Both traditional variable annuities and RILAs, which are also variable annuities, are subject to investment risk, including possible loss of principal. Investment returns and principal value will fluctuate with market conditions so that units, upon distribution, may be worth more or less than the original cost.

Fixed annuities are a more conservative option with the main goal of keeping your money protected while providing fixed interest. If you want or need the potential to earn more interest on that money, then you may want to consider a fixed index annuity (FIA). These financial vehicles offer a similar level of protection as a fixed annuity but with more accumulation potential through one or more selected benchmark indexes, similar to RILAs. To be sure, FIAs don’t offer the same level of potential gains as a traditional variable annuity or RILA, but they do involve less risk through its principal protection.

Check the features

Once you have worked with a financial professional to figure out what style of annuity may fit your needs, you’ll want to look at all the products and carriers within the type you want. Within these broad categories, products vary widely. While there are some aspects to a product that can easily be compared — like rates and caps — many features or potential benefits available through additional riders (which may incur an additional cost) could make one product a better fit over another. 

Some products offer buffers against index losses or an ability to lock in potential gains. Some may add optional death or living benefit riders that may also incur an additional cost.

Questions you’ll want to consider:

• What flexibility will the annuity offer to withdraw money?
• What levels of protection does it offer?
• How will this product help address risks to my retirement like inflation and market volatility?
• What is the financial strength of the annuity provider?

It’s important to take a holistic view of these products as you review them with the guidance of a financial professional and tax adviser, as applicable. They can help you sort through the products to find one that may be appropriate for your personal financial situation, because there is no one-size-fits-all “best” annuity. The appropriate annuity is the one that will help meet your needs and attain your retirement goals.

Any distributions are subject to ordinary income tax and, if taken prior to age 59½, a 10% federal additional tax.

Exercising an index lock may result in a credit higher or lower than if the index lock had not been exercised.

Guarantees are backed by the financial strength and claims-paying ability of the issuing company. Variable annuity guarantees do not apply to the performance of the variable subaccounts, which will fluctuate with market conditions.

Products are issued by Allianz Life Insurance Company of North America and distributed by its affiliate, Allianz Life Financial Services, LLC, member FINRA, 5701 Golden Hills Drive, Minneapolis, MN 55416-1297. 800.542.5427 www.allianzlife.com This content does not apply to the state of New York.

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Are you an active investor, adjusting your strategy as the market tides shift? Or are you passive, going with the flow even when the flow carries you into a precarious situation?

In retirement, it pays to have a plan that allows you to adapt to new conditions, making decisions that best align with the particulars of the present. This doesn’t mean you need to be a day trader, constantly monitoring the S&P 500 and buying and selling by the hour.

But, since retirement is when you begin to spend the money you devoted decades to saving, you want to draw on that money in a strategic manner so you stretch your dollars as far as possible. After all, retirement should be a happy time of traveling, taking up new hobbies or spending more time with grandchildren. For too many, though, retirement can be a time of anxiety as they struggle to make their finances line up with their vision. Too often, it seems, bringing the two into alignment is a challenge.

But one way to keep your retirement on track is to be an active participant — not just when creating a retirement plan, but also when implementing it. When you’re engaged with your plan, you can align your decisions to the market conditions of the moment.

Get tactical with your withdrawals

Let me elaborate.

Sometimes people take a “set it and forget it” approach to their retirement finances. The market churns along with its ups and downs, and they pay no attention to what those ups and downs mean to them — or to their precious savings and investments.

This inattentiveness is a bad idea. When it comes to investments, what you don’t know definitely can hurt you.

If you monitor the market, though, you give yourself the opportunity to be strategic when you make withdrawals from particular accounts because the timing for your withdrawals can make a difference.

This is why I recommend retirees divide their money. Keep some in the market where the potential for strong gains is possible. Invest another portion in an annuity that is not susceptible to the lowest lows of market volatility. If the market is strong, you can draw on your burgeoning brokerage account to help with your monthly retirement income needs. In a down market, you can turn to your annuity.

Make decisions from a position of strength

Generally, when people think of annuities, they think of something that provides a lifetime income. You pay a lump sum to an insurance company, and in return, they make regular monthly payments to you, much like a pension.

That is one way an annuity works. But it’s not the only way.

Some annuities can also be liquid. In other words, you can have access to at least a certain portion of your money, making withdrawals to help with your income needs. You can get a guaranteed stream of income while still allowing your principal to be invested for growth. If you add an enhanced liquidity rider, if you don’t draw from the annuity one year, you can take more from it the next. Another great thing about these annuities is while they have growth potential, they are also guaranteed against loss, so they don’t carry the same risk as investing in the stock market.

Of course, there are limits to the gains you can make as well. This is why you want some of your money in the market, where there is potential for greater growth. Then you can be intentional with when and from where to make withdrawals.

If the market is on an uptick, you should peel off money from some of the stock investments that have provided a good return. A down market, when selling a stock could result in a loss, is a good time to draw from the annuity.

With such a back-and-forth strategy, you are always drawing on your savings from a position of strength rather than a position of weakness.

This approach also gives you a chance to stay active in the market. When the market drops, that’s an opportunity to take advantage of the liquidity of your annuity and buy stocks at low prices. Then, when the market rebounds and the value of those stocks grows, you can capitalize on your gains and draw on those, rather than from the annuity. (If that sounds like the classic “buy low and sell high” concept, that’s because it is.)

True, making the right move at the right time can get tricky. But a financial professional who has a good understanding of this approach will be able to give you proper guidance, so you can make decisions with confidence and get back to turning your retirement vision into your retirement reality.

Ronnie Blair contributed to this article.

The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

Securities and advisory services offered only by duly registered individuals through Madison Avenue Securities, LLC. (MAS), Member FINRA & SIPC, and a registered investment advisor. Dynamic Wealth Strategies and MAS are not affiliated entities.

Annuity guarantees rely on financial strength and claims-paying ability of issuing insurance company. Annuities are insurance products that may be subject to fees, surrender charges and holding periods which vary by carrier. Annuities are not FDIC insured.

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Perhaps that’s because other than Social Security, we rely largely on ourselves for building savings and the plans to access those savings to the best effect when we retire. The IRS, however, has spent some time on this issue, too, and that may prove helpful.

IRS rules encourage lifetime income protection through annuities

The IRS actually offers tax incentives that can help you provide lifetime income on a tax-advantaged basis.

Tax rules encourage investors to take care of their retirement plans through the purchase of different forms of lifetime annuities. Now, it’s OK to be skeptical about supposed government largesse, but please read the following information before making up your mind.

• Single premium immediate annuities (SPIA). A portion of each annuity payment is considered a tax-free return of principal when purchased from your personal (after-tax) savings. In today’s market, for a female at age 70, only 22% of a life-only payment is taxable until her age 85.
• Fixed, variable or index deferred annuities (DAs). These annuities can be exchanged tax-free to a SPIA or deferred income annuity (DIA) with any taxable gain spread over future annuity payments. And partial exchanges from DAs are permitted.
• Qualifying longevity annuity contract (QLAC). An IRA account holder can take up to $200,000 of the account and by purchasing a QLAC can defer RMDs on that amount until age 85, when lifetime annuity payments begin.

At the same time that you’re saving money on taxes, these annuities are generating more income, and a larger portion of your total income is guaranteed for your lifetime. By the way, with an improved income plan, you may be able to delay claiming Social Security benefits and grow lifetime income from that source. Or you can use a portion of the tax savings to provide beneficiary protection on your annuity payments.

Tax benefits from adding lifetime protection to your plan

Let’s go back to our sample investor, a woman at 70, whose current portfolio is invested as below. She’s following the “100 minus age” rule with a 30% allocation to stocks.

• $750,000 in personal savings: $225,000 invested in high-dividend stock investments (30%) and $525,000 invested in fixed income investments (70%)
• $750,000 in a rollover IRA: Invested in a balanced portfolio (30% in stock investments)
• Her home is worth $1 million free and clear but is not part of her income plan

Her first-year income goal from these savings is $96,000, or $8,000 per month. And she wants her income to grow by 2% a year as a hedge against inflation. That’s a pretty aggressive starting income goal of over 6% of her savings.

To achieve that goal beyond her $5,600 from monthly interest, dividends and IRA withdrawals, she needs to withdraw another $2,400 per month, probably from her rollover IRA account. With this approach, she runs the risk of running through her IRA savings.

To do her taxes, we need to know her other income sources: She also has $36,000 in annual Social Security benefits and $26,000 from a pension.

If she leaves her plan as is, she is paying an estimated $27,000 in first-year taxes and retaining a large portion of the lifetime income risk. That’s not what the IRS intended.

Investor considers Go2Income planning

She’s open to considering the Go2Income planning method that includes income annuities to lower her taxes and her risks. With the additional income from annuity payments, she’s reducing her income risk and lowering the extra withdrawals she has to take to meet her $8,000-per-month goal to about $1,000 per month. She’s also increased her safe income from 32% to 49% of the total income from savings.

And, by bringing in the guaranteed lifetime income of the annuity payments, she’s taking advantage of the IRS rules and lowering her estimated first-year taxes from $27,000 to $21,000.

The gotcha of this plan to some is that to get the benefits of an annuity’s lifetime protection, and a higher payout, you have to give up access to the value of the annuity, otherwise known as liquidity. (If you had full access along with the annuity, you couldn’t get the benefit of the longevity credits, which is worth 15% or more in cash flow.) You can get a quote here on how much income you can get with a SPIA.

Here’s one possible answer to the gotcha. There’s an asset hiding in plain sight that can take these tax advantages and income protection and deliver additional income and liquidity. It’s your home, and the vehicle is a home equity conversion mortgage, or HECM. Let’s see how you could build it into your plan.

Using an HECM as part of HomeEquity2Income

An HECM is a type of reverse mortgage backed by the government that allows homeowners to convert part of their home equity into cash. We’ve discussed the features of an HECM in earlier articles, but the one thing we haven’t emphasized is the tax-free nature of the HECM drawdowns. Many Boomers have 25% to 40% of their net worth in home equity, and most are not accessing it for supplemental retirement income.

Integrating HECM into a new approach to retirement income called HomeEquity2Income (H2I) allows clients to access their home equity, reduce their taxes and increase their financial flexibility. See my article How to Add Home Equity to Your Retirement Income Planning to learn more about this.

H2I combines an HECM and a QLAC to provide an efficient source of lifetime income and liquidity for Baby Boomers, particularly those looking to age in place and concerned about the costs of bringing in care providers or upgrading their residence. H2I allows them to access it tax-effectively without selling or renting their house.

Compare our investor’s plan with H2I to the original plan

Here are the key benefits of the plan with H2I vs her original investment-only plan:

• No extra drawdown from our investor’s retirement savings is required. About $1,000 per month is coming from an HECM
• The percentage of income that is considered safe increases from 32% to 68%
• Liquid savings at age 85 to meet unplanned expenses are increased by over $500,000
• Estimated first-year income taxes are reduced from $27,000 to $15,000

The accumulated value of reinvesting those tax savings over 15 years for our sample investor is an additional $250,000.

Bottom line: Lower taxes, lifetime income, liquid savings — and even more

It may seem like a circuitous path to use tax savings combined with an annuity’s lifetime protection and further tax savings that come from accessing the value in your home. But with the help of the IRS, it all makes sense. If you need help in understanding this process, our Go2Specialists can explain in more detail.

Visit Go2Income to put together your own plan to step up your lifetime income and liquid savings. A Go2Specialist will be available to answer questions and guide you through the process.

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Among experts cautioning against annuities is financial guru Suze Orman. Her stance primarily stems from concerns about high fees and complex structures. Traditionally, annuities have been criticized for their lack of transparency and the potential for excessive costs eating into the returns. This skepticism has created a barrier for many investors, preventing them from considering annuities as viable retirement planning tools.

The rise of RILAs

RILAs have entered the scene as a modern alternative that aims to address the concerns associated with traditional annuities. For one thing, RILAs impose no direct fees to policyholders. The provider earns a percentage of the RILA’s investment return, similar to various mutual funds and other investment management programs.

In addition, RILAs offer a combination of upside potential and downside protection. Returns are tied to a market index, enabling policyholders to:

• Realize gains up to a specific level
• Avoid losses beyond a certain level, if the underlying index experiences a decline

About fixed indexed annuities (FIAs)

Another recent arrival in the annuity marketplace is gaining popularity among retirement-conscious individuals. Like RILAs, FIAs charge no direct fees. They also link returns to a market index.

However, they differ in that FIAs offer a guarantee. Policyholders cannot suffer losses even if the underlying index declines. In return, their upside potential is limited to an annual cap — typically 7% to 11%, depending on the provider and annuity contract.

Investors may find it extremely attractive to track a market index performance with no chance of market losses and no fees, even though their upside capture is limited.

Advantages of RILAs and FIAs

No direct fees. RILAs and FIAs stand out for their fee-free structures, ensuring that a significant portion of the investment is dedicated to potential growth rather than being eroded by fees.

Market-linked returns. Both RILAs and FIAs offer market-linked returns, allowing policyholders to benefit from market upswings while providing protection during market downturns.

Downside protection. The innovative design of these annuities incorporates downside protection, mitigating the impact of market volatility and offering a more stable approach to retirement planning.

Transparency. The transparent fee structures of RILAs and FIAs address the concerns about hidden costs, contributing to increased transparency and fostering trust among investors.

Customization options. These annuities often provide customization options, allowing investors to tailor their policies to align with specific financial goals and risk tolerances.

Disadvantages of RILAs and FIAs

The downside to both RILAs and FIAs is that the performance is usually capped either on an annual basis or after a period of time such as six or seven years. Even though they are tracking well-known indexes, such as the S&P 500, these annuities do not credit dividends, only the price return.

They also have a surrender charge during their holding periods.

Lastly, if non-qualified money is invested, once the money is withdrawn, it is treated as income and not capital gains.

Changing the perception

The introduction of RILAs and fee-free FIAs challenges the prevailing negative perceptions surrounding annuities. By focusing on transparency, reduced fees and innovative structures, these products are shifting the conversation toward annuities as viable, cost-effective tools for retirement planning.

As more investors seek efficient and reliable strategies for securing their retirement savings, RILAs and FIAs are proving to be transformative forces, reshaping the perception of annuities and redefining their role in financial planning.

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Cash balance pension plans became popular in the late 1980s and early 1990s, especially with companies such as IBM, Xerox and AT&T, which at the time had large liabilities in their traditional defined benefit pensions. Cash balance pension plans emerged as a hybrid between traditional defined benefit plans (aka, a pension) and defined contribution plans (such as a 401(k) plan), offering employees a portable retirement benefit. The plans gained popularity among employers seeking to manage their costs and risks, while providing competitive retirement benefits.

Individuals with a cash balance pension plan face numerous decisions as they near retirement. Understanding the various options available is crucial for maximizing retirement income and ensuring financial security.

Let’s review the considerations and choices one should explore when navigating their cash balance pension options.

The basics

Unlike traditional defined benefit pensions, which provide a specific monthly benefit upon retirement, a cash balance pension maintains a hypothetical account balance that grows based on company contributions and interest credits. Unlike a 401(k), the employee can’t select a menu of investment options from which to invest their balance. The company determines the cash balance plan’s crediting rate, sometimes quarterly, but most often set annually. Here are a few companies’ cash balance pension plans’ crediting rates for 2024:

• GlaxoSmithKline: 3%
• Duke Energy: 4.46%
• IBM: 5%

Upon retirement or separation from service, employees typically have several distribution options.

Option 1: A lump sum payment in cash.

Cash balance participants may consider taking a lump sum payment from their cash balance pension. However, the entire payment is taxed as ordinary income, which can be very costly. Participants should carefully weigh the tax implications associated with a lump sum distribution.

Option 2: An IRA rollover.

Participants can roll over their cash balance pension to an IRA. A direct rollover to a qualified retirement account is not taxable — but any withdrawals you take later on will be taxed. An IRA rollover offers a couple of major advantages: It provides the participant with greater investment options, and it allows for more flexible income tax planning.

Keep in mind that if you leave a company before retirement, some companies don’t allow a rollover until the participant reaches a specified age. In addition, some employers require those with small cash balance pension benefits (say under $10,000) to exit the plan — either in lump sum or IRA rollover — when separating from service.

Option 3: Annuity payments.

Another option is to convert the cash balance pension into a series of annuity payments. Annuities provide a steady stream of income over a specified period, offering retirees a predictable source of retirement income. Retirees should compare different annuity providers and payment options to find the most suitable arrangement for their financial needs and goals.

Participants can also opt for some combination of these different options. For example, a participant might decide to take annuity payments for 50% of their cash balance pension and do an IRA rollover with the other 50%.

Other considerations

As interest rates have risen, the crediting rates of some cash balance pension plans are lower than CD rates, making the rollover option more attractive. Participants should also remember that cash balance pension plans are subject to the same required distribution rules as IRAs.

Cash balance pension plans are an often-overlooked component of one’s retirement nest egg. Navigating retirement options with a cash balance pension requires careful consideration and planning. By understanding the available options, evaluating individual goals and managing cash balance pensions in concert with 401(k) and Social Security benefits, retirees can pave the way for a secure and fulfilling retirement journey.

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A recent study from Northwestern Mutual found that adults across the U.S. believe they will need $1.46 million to retire comfortably. That’s a 53% increase compared to the $951,000 many believed they would need back in 2020.

Unfortunately, the amount Americans actually have saved is dropping. According to the same study, the average American had $89,300 saved in 2023. That number has dropped to $88,400 in 2024. So what does this mean when it comes to long-term health care costs, and what can you do now to avoid financial stress in your golden years?

Before you can formulate a plan to attack health care costs in retirement, it’s important to understand the federal programs in place and how much coverage they provide.

Federal programs and their coverage

Once you turn 65, you become eligible for Medicare. Medicare is a federal insurance program that is meant to help offset health care costs in retirement. Part A covers in-patient hospital stays, hospice care and some home health care. Part B covers certain doctor’s visits, outpatient care, medical supplies and preventive services. Part D helps cover the cost of prescription drugs. Although there are many parts to Medicare, it doesn’t cover everything — forcing some people to enroll in supplemental insurance programs known as Medigap plans. However, the plans may only cover a certain amount depending on how much money you have saved.

The Employee Benefit Research Institute found a 65-year-old man enrolled in a Medigap plan with average premiums will need to have $106,000 saved just to have a 50% chance of having enough to cover premiums and average prescription drug costs. That number jumps to $128,000 for women. This difference in cost is likely due to the fact that women tend to live longer than men. To have a 90% chance of covering health care costs in retirement, the average man will need $184,000 in savings; women will need $217,000. According to the CDC, the average life expectancy for women is 79; for men, it’s 73.

Based on these findings, it’s safe to say health care costs will take a decent chunk from your retirement fund — but don’t let these numbers paralyze you. There are small steps you can take now to help you become more financially secure in retirement.

1. Maintain a healthy lifestyle.

It's obvious advice, but it bears repeating. If you make an effort to stay active and eat healthy, you'll likely spend less on health care than someone who ignores diet and exercise and has other unhealthy habits such as smoking.

2. Boost your retirement savings.

Generally speaking, the sooner you start saving for retirement, the better off you’ll be. If possible, increase or max out contributions to your employee savings plan.

The IRS also allows adults over the age of 50 to make annual catch-up contributions to certain accounts:

• 401(k). You can contribute an extra $6,000 each year.
• 403(b). Employees with at least 15 years of service can contribute up to $6,000 annually.
• IRA. For either a traditional IRA or Roth IRA, you can contribute up to $1,000 more each year.

3. Open a health savings account (HSA).

If your employer offers a health plan that is HSA-eligible, consider enrolling. As part of the plan, you can contribute to a health savings account (HSA) without a tax penalty. Your contributions are made pre-tax. As a bonus, your savings grow tax-free, and you can withdraw money tax-free as long as it is used for qualified medical expenses.

4. Consider your retirement age.

The average age of retirement is 62 for most Americans. While three extra years of retirement may sound good, there are some serious drawbacks. During those three years, you won't be able to contribute to employee-sponsored savings plans. You won't have a steady income. You also won't be eligible to enroll in Medicare until you are 65. That means you’ll be paying out of pocket for health insurance for three years.

5. Live like you are already retired.

An easy way to boost your savings is to cut back on your spending. Start by envisioning your retirement and look for costs to cut. If that vision involves downsizing your home or cooking healthy meals at home, begin making those changes now. Limit the career clothing you buy. Consider purchasing a more economical car. These changes will save you money right away. They will also make the transition into retirement easier.

Unfortunately, doctor visits and medication costs aren’t the only health care expenses you’ll need to account for. Another major factor you’ll need to consider is where you’re going to live as you age — especially if you become cognitively impaired. Data from Genworth found that in 2023 Americans could spend up to $75,504 annually for in-home care, $64,200 for assisted living care and up to $116,800 for nursing home care. Those costs alone could eat through your retirement savings in just a few years. Fortunately, there are several long-term insurance plans that can help offset these costs.

Here are some common plans:

Long-term care insurance. This type of insurance is specifically designed to cover the costs of long-term care services. Policyholders pay premiums in exchange for coverage, which can help cover home care, assisted living or nursing home care expenses.

Hybrid life insurance with long-term care rider. Some life insurance policies offer a long-term care rider, allowing policyholders to access a portion of the death benefit to cover long-term care expenses if needed. These policies provide both life insurance coverage and long-term care benefits.

Annuities with long-term care benefits. Certain annuity products include long-term care benefits that can help cover expenses if the annuitant requires long-term care. Annuities with long-term care riders may offer a lump-sum payment or monthly benefit to cover care costs.

Medicaid. Medicaid is a joint federal and state program that provides health coverage to eligible low-income individuals, including coverage for long-term care services. Eligibility criteria vary by state, but typically income and asset requirements must be met to qualify.

Employer-sponsored plans. Some employers offer long-term care insurance as part of their benefits package. These plans may provide coverage for employees and their eligible family members at group rates.

Accounting for long-term health care is a crucial part of retirement planning. There are a number of steps you can take to help grow your savings now, and there are some insurance options for covering long-term care expenses.

As you’re planning, consider your current health status, cost of care, health insurance coverage, financial resources, family support and personal preferences. Taking these factors into account can help you make an informed decision that best suits your needs.

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