The usual advice for retirees is to gradually reduce and then often eliminate exposure to high-risk investments like stocks as you get closer to retirement.
An annuity, however, is one potential way around that.
“If you have a base of income that covers your expenses, your fundamental expenses, through some sort of annuitized income,” then “essentially that takes away the downside risk and it allows you to take more risks with the remainder of your investment portfolio,” Michael Finke, professor of wealth management at the American College of Financial Services, said on Yahoo Finance’s YFi PM.
An annuity is a fixed sum of money paid each year, typically for the rest of your life. You have a contract with an insurance company in which you make a lump sum payment or series of payments and, in return, get regular disbursements. (Social Security is a kind of annuity, said Finke.)
In 2018, the maximum Social Security benefit for a worker retiring at full retirement age was $2,788 a month. In 2019, the maximum benefit rose by $73 per month to $2,861. That income, Finke argues, combined with a private annuity would allow retirees to use their remaining assets for stocks.
“We've actually estimated that the optimal portfolio for those who have more annuitized income is more heavily weighted towards stocks than when there is less of an annuitized income,” he said.
Finke appeared as part of Yahoo Finance’s ongoing partnership with the Funding our Future campaign, a group of organizations advocating for increased retirement security for Americans.
In his research, Finke and David M. Blanchett, head of retirement research at Morningstar Investment Management, write that “when a retiree buys an income annuity, they should optimally take more investment risk with the remainder of their investment portfolio.”
“Even risk-averse retirees should hold a significant allocation to equities if they have a large percentage of total wealth held in guaranteed income assets,” they wrote.
The guaranteed incomes from the annuity and Social Security would mean retirees would not need to adjust their standard of living based on the ups and downs of the market.
A recent study from the Stanford Center on Longevity analyzed plans for middle-income individuals to set up their plans to essentially make their returns into an annuity. The study was partly based on the idea that delaying Social Security for as long as possible will maximize the financial health of retirees as they live longer.
There is legislation currently being considered on Capitol Hill that includes provisions to encourage retirees to annuitize and gain more predictability in their retirement income. The legislation has passed the House but remains pending in the Senate.
Finke’s plan “gives you the ability to achieve that clarity that previous generations of retirees were able to achieve through a defined benefit system through a traditional type of pension” he says.
Ben Werschkul is a producer for Yahoo Finance in Washington, DC.
Read more:
Retirement expert: The 'easiest' crack to fix in the system is workplace access
On Social Security, 2020 candidate plans miss this one critical issue
A plan that could save Social Security and boost the economy — with one big catch
Read the latest financial and business news from Yahoo Finance
Follow Yahoo Finance on Twitter, Facebook, Instagram, Flipboard, LinkedIn, YouTube, and reddit.
