Dr. Pfau's Advice on How to Retire in a Low Interest Rate Economy
Are there any other benefits to owning an annuity in a lower-interest rate environment?
Pfau believes there are. An annuity can provide you with downside protection. This means that you can consider your guaranteed monthly annuity payments as coverage for your "everyday" living expenses, and then use the rest of the money in your portfolio to invest more aggressively for growth.
In many ways, having the annuity could even replace the need for bonds in your portfolio, Pfau said. Plus, annuities can offer you the added benefit of mortality credits. These are what essentially add to the "return" of those who live longer by pooling their risk with those who do not live as long.
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Living a long life can be great, but it will certainly cost you a lot more to support. Nobody knows how long they will live - but the risk of living a long life will obviously require more income for a longer period of time. This longevity risk is the "problem" that an income annuity can solve.
What are some of the biggest risks that investments in retirement face?
In addition to low interest rates, which can lead to low returns from fixed income investments, some of the other key risks can include: longevity risk, inflation risk, cognitive decline, investment volatility, and sequence of returns risk, Pfau explained.
These risks, however, as they pertain to retirement income, can be reduced or even eliminated with the proper planning, he said. For example, by choosing the lifetime income option on an annuity, you can receive income for the remainder of your lifetime - regardless of how long that may be.
The sequence of returns risk refers to the greater vulnerability that you face in the years around your retirement date. Here, a negative period of returns just before or after you begin to take withdrawals from your portfolio could cause you to run out of money faster - in some cases, much faster, Pfau said.
However, here again, by "pooling" your funds with an insurance carrier - as is the case with an annuity - you will be able to "hedge" your risk, and again be able to rely on a guaranteed stream of income from that annuity, regardless of what occurs in the market or with interest rates.