Managing Risk with Fixed-Indexed Annuities

Wade D. Pfau, Ph.D., CFA

The role of fixed index annuities in the pre-retirement years.

The United States has experienced a low interest rate environment in recent years, leading to lower returns for fixed income assets. This creates unique challenges for those approaching retirement, as the practical impact of low interest rates is an increase to the cost of funding retirement goals.

Households may seek to offset these rising retirement costs in numerous ways. On the fixed-income side, they may seek higher bond yields by either investing in longer-term bonds with greater risk of capital losses if interest rates rise, or in higher yielding corporate bonds that create greater credit risk for the financial plan. Longer maturity bonds may offer higher yields, but they will experience capital losses with a rate increase. Shorter-term bonds may not experience losses with rising rates, but their lower yields may lead to unsatisfactory returns. Though bonds are generally perceived to be less risky assets, they are exposed to interest rate risk. Near-retirees who are depending on bond funds to maintain the value of their assets may be vulnerable to having their financial plan steered off course by a rise interest rates during these key pre-retirement years.

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