How Annuities Can Help Address Sequence-of-Returns Risk

A practical examination of annuity contracts, lifetime income and the risks retirees face when converting savings into cash flow.

An annuity is a contract with an insurance company. Investor.gov explains that annuities can provide tax-deferred accumulation and can be structured to make periodic income payments, including payments that may continue for life depending on the contract and payout election. That lifetime-income feature is what separates an annuity from an ordinary investment account: the contract can transfer some longevity risk—the risk of living longer than expected—to an insurer.

Annuities are not one product. Fixed, fixed indexed and variable annuities can behave very differently, and income guarantees may come through annuitization or optional contract benefits. Guarantees are subject to the issuing insurer’s claims-paying ability. Contract owners should also evaluate surrender periods, liquidity, fees where applicable, crediting methods, caps or participation rates for indexed strategies, beneficiary provisions and tax treatment before deciding whether a contract fits a retirement plan.

Average return does not tell the whole retirement story

Two retirees can earn the same average investment return and experience very different outcomes if the order of gains and losses differs. While working, a market decline can be uncomfortable but continued contributions may buy assets at lower prices. In retirement, withdrawals reverse the math: selling after a decline permanently removes shares that can no longer participate in a recovery.

Why an income floor can change withdrawal behavior

Social Security and pensions already function as income floors for many households. Certain annuity contracts can add another stream of contractual income. If essential expenses are partly covered by sources that do not require selling market assets each month, the retiree may have more discretion over when to take portfolio withdrawals during volatile periods.

An annuity does not “solve” market risk

The remaining portfolio can still lose value, inflation can erode purchasing power, and the annuity introduces insurer credit risk and product-specific limitations. The goal is narrower: reduce dependence on variable portfolio withdrawals for a chosen portion of spending. This can make the distribution plan more resilient even though it does not eliminate investment risk.

Bucket the expenses before choosing a product

A useful process is to separate essential expenses—housing, food, utilities, baseline health costs—from discretionary expenses such as travel and gifts. Then compare guaranteed income already available with the essential-spending target. Any gap becomes the amount for which additional contractual income might be evaluated. This prevents the common mistake of deciding on an annuity allocation before defining the income problem.

Liquidity still matters

Retirees need accessible reserves for emergencies, large purchases and opportunities. Allocating too much to an illiquid or surrender-charge contract can create a different risk. A balanced plan considers guaranteed income and liquid reserves together.

References & further reading

1. Investor.gov (U.S. SEC), Annuities.
2. Investor.gov (U.S. SEC), Updated Investor Bulletin: Indexed Annuities.
3. Investor.gov (U.S. SEC), Updated Investor Bulletin: Variable Annuities.