In the world of financial planning, annuities can be a game-changer. They come in various forms, with fixed and variable annuities being the most common. But what happens when a recession comes knocking on your financial door? In this blog post, we’ll delve into the intriguing world of annuities, explore how they work, and uncover the risks they bring during economic downturns.

How Annuities Work

Your Retirement Salary Annuities are unique investment products often starring in retirement planning. You won’t find them in your typical stock exchange or brokerage. Instead, they’re managed by life insurance companies, and the friendly face most likely to introduce you to annuities isn’t your run-of-the-mill stockbroker but an insurance agent.

Here’s the kicker: when you reach the ripe age of 59½, some annuities start to pay out their cash value through a series of fixed payments. Depending on the annuity’s setup, these payments might come monthly for five years, ten years, or even the remainder of your life. Annuities offer something remarkable – a retirement salary. Once those distributions begin, you get a regular paycheck, with the amount always staying the same.

Fixed vs. Variable Annuities: Risk vs. Reward 

The primary distinction between fixed and variable annuities lies in their interest-accumulating phase. A fixed annuity guarantees a set interest rate during this period, making it more akin to a certificate of deposit (CD) than a rollercoaster ride in the stock market. Interestingly, fixed annuities are not classified as securities, so the Securities Exchange Commission (SEC) doesn’t oversee them, and the sellers don’t need a Series 7 or Series 63 license.

Many life insurance agents must be authorized to sell securities and have a soft spot for fixed annuities. The commissions they earn from these are substantial.

Conversely, variable annuities are like thrill-seekers in the world of grants. Their return rate depends on the investment tool they’re tied to, often in the form of subaccounts resembling mutual funds. These subaccounts contain a mix of stocks, bonds, and money market instruments.

But here’s the catch: because these investments, particularly stocks, react to economic conditions, variable annuities are like surfers riding the waves of market risk. In times of economic downturns, the value of the investments can shrink, causing your annuity balance to decline. Fixed annuities don’t play this risky game, but they won’t turbocharge your balance during economic upswings.

Qualified Longevity Annuity Contracts (QLACs)

Looking for a lifeboat to navigate the stormy waters of economic uncertainty? Consider a Qualified Longevity Annuity Contract (QLAC). This annuity type is a deferred annuity funded by moving money from an individual retirement account (IRA) or a qualified retirement plan, such as a 401(k).

QLACs provide regular monthly payments until the owner’s passing, offering shelter from economic and market turbulence. Moreover, the SECURE 2.0 Act of 2022 enables individuals to transfer up to $200,000 of their retirement savings to a QLAC. And here’s the bonus: QLACs are not subject to the IRS’s required minimum distribution (RMD) rules, which mandate withdrawals from IRAs beyond a certain age. Plus, you can delay the start of your QLAC payouts, making them kick in when you’re comfortably sipping tea at 80.

Annuities: A Steady Ship in a Storm 

No financial product can claim to be entirely recession-proof, but annuities may offer you a lifeline during tumultuous times. Still, before setting sail into annuity waters, consulting a financial advisor is essential to ensure they align with your financial needs and goals.

What’s the Riskiest Annuity? 

A variable annuity might be your cup of tea if you’re a thrill-seeker. Your premiums venture into investments, and their performance dictates the rate of return. When investments flourish, you reap the benefits. But you might witness a meager or even negative return when they falter.

What’s the Safest Annuity? 

On the other side of the spectrum, fixed annuities offer a safe harbor. With guaranteed interest rates and principal protection, they’re like the steady hand at the helm in the annuity world.

Managing Annuity Risks: Diversify and Conquer 

The secret sauce for handling annuity risks lies in diversification. A well-balanced portfolio should encompass a mix of investment options such as stocks, bonds, and cash. Consider blending fixed and variable annuities for extra income during retirement, and you’ll have a strategy that can weather any financial storm.