How Much of Your Retirement Savings Should Be in a Fixed or Fixed-Indexed Annuity?

fixed-indexed annuity

How much is too much when it comes to annuities? One of my clients had that question when he was trying to reallocate his retirement assets. It’s a tricky question but an important one. Allocating retirement assets is a delicate balancing act and one that must be looked at on a deeper level than high risk and low risk. Instead, it might help to work backward and start with how much you need to live on to cover your mandatory and optional expenses. For some, fixed and fixed-indexed annuities can fit in by supplementing that income to cover some of those future mandatory costs.

Allocating Your Expenses and Risk Levels

Any financial vehicle you choose is usually going to come with some level of risk, whether it’s the risk that you’ll lose your money, the risk that your money won’t grow fast enough, or even the risk that your money may not be liquid. That’s why allocating that risk is so important. Some may keep a certain amount of higher-risk assets to keep up with inflation, while using lower-risk assets to help ensure a steady stream of future income.

Like your money, your expenses can be allocated into certain levels of risk. There are some expenses you must be able to cover and some you don’t need to worry about as much. Generally, many people will have a mix of optional, reducible, and mandatory expenses. Optional expenses are anything that you could live without. Next, you have your reducible expenses or things you could reduce or “trade down” in a pinch, like a car payment. Finally, you have the basic expenses of modern living, like utilities, housing, and medical care.

Each of those amounts can be used to make up a rough percentage of your living expenses. For example, say you want to make $4,500 a month to keep up with your standard of living. You spend $1,500 per month on entertainment and would need a bare minimum of $1,000 a month to live on.

The budget (roughly) is broken into 30% optional expenses, 20% mandatory expenses, and 50% reducible expenses. So, one strategy could be to fund the mandatory expenses with lower-risk assets, while the optional expenses could be funded with the higher-risk assets.

Fixed annuities and indexed annuities could be used to fund a portion of those mandatory, must-have expenses because of their lower-level of market risk. While they don’t generally offer the potential for extremely high returns, they offer a guaranteed income stream that you can’t outlive. Those guarantees are backed by the financial strength and claims-paying ability of the issuing company.

Allocating Money to Fixed and Fixed-Indexed Annuities

One way to use a fixed annuity is as a means to supplement Social Security income and your other investment income. It can guarantee an income payment on top of what you receive from social security to help with those basic costs of living where the price doesn’t fluctuate as much over the short-term, like groceries, housing, and utilities. Another option is to pair an annuity with bonds or other lower-risk investments.

Keep in mind annuities, if appropriate for your situation, should only be used to fund a portion of your retirement portfolio. Like all financial vehicles, annuities do have some limitations, such as liquidity issues, insurance fees and charges, and the potential for limited interest crediting.

The Risk of Overdoing It

While annuities can be used to supplement necessary expenses for many, they shouldn’t be the sole means of it. The tradeoff with annuities is that you might not see interest credits that are high enough to keep up with inflation.

That’s why other financial vehicles may be able to balance your risk/return portfolio. Breaking down your retirement allocation by expense is a good way to get a general idea of your own level of future expense risk.

Annuities should be used as a means to supplement income and not become the entire basis of it. Using it to cover a certain portion of your future expenses, like medical costs or utilities, can allow you to manage the low-risk side of your portfolio more effectively.

Allocating your retirement funds isn’t easy, and each individual’s situation is unique. However, adding annuities to the mix, when appropriate, can help add a bit of simplicity and guarantee future funding for necessary expenses. However, there’s no true one-size-fits-all formula for doing it. Instead, we recommend consult with an insurance professional, such as one in our Retirement HQ’s network, to help you determine the right mix of assets in your portfolio.