Some Creative Options to Reduce Investment Risk in IRAs
CDs and bonds have a role, but less-used annuities can offer higher interest rates, secure principal and guaranteed income choices.
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People approaching or in retirement should not have an over-weighted stake in equities. If you need to reduce risk in your IRA and/or Roth IRA, what are the best ways to do it?
A bank certificate of deposit (CD) is a reasonable choice … but a fixed-rate annuity can be an even better choice.
Both CDs and fixed annuities let you protect your savings from market risk, earn a set rate of interest and guarantee your principal. But fixed-rate annuities have the edge because they usually pay substantially more than a CD with the same term.
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For instance, you can buy a five-year annuity that pays a 3.15% annual rate (as of November 2021). The top five-year CD pays 1.25%: 60% less interest.
Fixed-rate annuities also have advantages over bond funds. Bond funds are totally liquid but do not guarantee a rate of return. If interest rates spike, the share price will decline, perhaps substantially.
All annuities fall into two basic groups: immediate and deferred. The latter are called deferred because you’re normally not taking income out in the short term. Reinvesting the interest lets your principal grow faster. Beyond that, annuities can be broken down further into several types:
CD-type annuities
The fixed-rate deferred annuity, mentioned above, is sometimes called a CD-type annuity. Its formal name is the multi-year guaranteed annuity, or MYGA — a tongue-twister of a name for a simple product.
Like a certificate of deposit, it guarantees a set interest rate for a number of years. MYGAs usually pay somewhat higher rates than CDs with a comparable term. For current rates, see this chart.
You can repeatedly renew an MYGA for additional guarantee periods at the end of each term. Or you may eventually choose to annuitize it: meaning you will convert it to a guaranteed stream of income for a set number of years or your lifetime.
Fixed-index annuities
The fixed-index annuity is the only product available that offers both market-based growth potential while still guaranteeing your principal.
It’s a have-your-cake-and-eat-it-too product. It can be a great halfway alternative.
This type of deferred fixed annuity offers a share of the gains, in the form of an interest rate credit, when the stock market goes up. In exchange for a guarantee that you’ll never lose money, you may get only part of the market’s annual gain as measured by an index, such as the Dow Jones Industrial Average (DJIA) or S&P 500.
If the market index is negative for the year, you’ll typically get no interest, but never a loss.
Experts expect the product to produce long-term returns that exceed that of bonds or fixed-rate annuities but trail equity returns, but without market risk and volatility.
You need to be willing to withstand some interest-rate uncertainty.
Optional guaranteed lifetime-income and/or withdrawal-benefit riders are commonly available for an additional fee.
Deferred income annuities
A deferred income annuity (DIA) can provide a guaranteed lifetime income. Also called a longevity annuity, it defers income payments to a future date you choose. It provides guaranteed lifetime, or joint lifetime, income after an initial holding period of anywhere from two to 40 years.
With a DIA, the income payout will be significantly higher than with an immediate annuity. The insurer rewards you for making a long-term commitment and deferring your payout.
A deferred income annuity (DIA) can work well with IRAs, but you’ll need to make sure your income payments begin no later than age 72 to comply with required minimum distribution (RMD) rules. If you want to defer income payments past that age, then you should consider a qualified longevity annuity contract (QLAC).
Qualified longevity annuity contracts
A qualified longevity annuity contract (QLAC) is a recent variation on the DIA. It’s designed to meet specific IRS requirements so that you don’t need to take required minimum distributions on the assets in the QLAC.
It’s the only way you can legally delay RMDs for a portion of your IRA funds and thus keep more money in your IRA longer.
You can invest up to $135,000 of IRA money in a QLAC. You can delay taking RMDs on the QLAC as late as age 85, instead of having to take them starting at 72 as you would with a standard IRA.
Immediate annuities
An immediate annuity pays income immediately. If you’re over 72, it also helps fulfill your required minimum distributions (RMDs). It’s a great way to get a guaranteed lifetime income.
An immediate annuity converts an asset to income efficiently, but in return, you have little or no ability to change the income stream once it starts.
Some retirees don’t like the idea of illiquidity. But it is very hard to obtain the same level of guaranteed lifetime income any other way, especially if you need income right away.
Every pre-retiree or retiree should consider annuities for part of their IRA portfolio. And while a CD-type annuity is always a good starting point, there are many other types worth investigating.
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