Are Annuities A Safe Investment In A Recession?

Recessions mess with even the most disciplined and experienced investors. When stocks tank, layoffs spike, and headlines scream economic uncertainty, it’s natural to reach for anything that feels safe. 

For some, annuities look like shelter from the storm. These insurance-based financial products promise a steady income stream in exchange for an upfront investment. 

However, annuities aren’t one-size-fits-all solutions. Some can genuinely reduce financial uncertainty and stress in a crisis. Others are riddled with fine print and hidden fees that could do more harm than good.

Before deciding whether annuities belong in your retirement portfolio, it’s important to understand what they actually offer and which ones are most likely to safeguard you from risk during a recession. 

Are annuities a safe investment during a recession?

Annuities are often pitched as reliable sources of income, and there’s some truth to that. 

Here’s how it works. An annuity is a contract between you and an insurance company. You pay either a lump sum or a series of payments, and, in return, the insurer promises to pay you income either immediately or at some point in the future. 

That kind of predictability is appealing when stock markets are anything but stable. 

However, not all annuities are created equal.

• Fixed annuities offer a guaranteed rate of return and are insulated from market chaos, making them a much safer option during a recession.
• On the flip side, variable annuities are tied to the performance of underlying investments, similar to mutual funds. If the market tanks, so can your income stream. 

To truly understand where annuities shine — and where they fall short — it’s helpful to take a closer look at the three main types of annuities: fixed, variable and fixed indexed. 

Fixed annuities are the safest option

If you’re looking for safety and predictability, fixed annuities are the simplest, most straightforward option. Fixed annuities guarantee a fixed rate of return and protect your principal from market losses. For retirees or those approaching retirement, that level of predictability can be priceless when everything else feels out of control.

Fixed annuities — especially multi-year guaranteed annuities (MYGAs) — share many similarities with certificates of deposit (CDs). You know exactly what rate you’ll get and how long it’ll last, and you’ll pay a penalty to access your money ahead of schedule. 

However, fixed annuities aren’t growth engines. Their returns are modest and generally won’t keep pace with inflation over the long haul. Still, current fixed annuity rates are much higher than in years past, and if you’re focused on capital preservation, they can be a solid addition to a diversified portfolio.

Variable annuities are riskier

A variable annuity takes your money and invests it in sub-accounts that function like mutual funds. That means your returns — and your future payouts — depend on market performance. 

If your investments lose value, your future income could shrink or fail to grow as you expected. Some variable annuities offer income riders or guaranteed minimum income benefits, but those guarantees come with fees and fine print that are hard to navigate. Alternatively, you could invest in a handful of inexpensive index funds for a fraction of the cost. 

And speaking of fees — variable annuities are loaded with them. Mortality charges, administrative fees, investment management charges, sales commissions and rider costs add up fast. All those expenses can eat into your returns, especially during a down market. 

So, if you’re trying to limit risk during a recession, variable annuities shouldn’t be your first choice. They’re complicated, expensive and tied to the very thing you’re trying to avoid — market volatility.

Fixed index annuities limit risk but pile on complexity

Fixed index annuities (FIAs) are pitched as a middle ground between the safety of fixed annuities and the upside potential of variable annuities. They tie your returns to a market index, such as the S&P 500, but cap your potential gains while shielding your principal from losses.

It sounds promising: You can’t lose money when the market drops, but you still get some potential growth. 

But once you peek under the hood and dig into an FIA contract, things get complicated fast. Caps, participation rates, spreads and other features limit your actual returns. For example, if the S&P 500 gains 10 percent but your annuity has a cap of 4 percent, you only get 4 percent.

And if you cash out early, surrender charges apply, just like with any annuity. 

FIAs may sound like a clever hedge during a recession — and they might be for the right person in the right situation. But it’s essential to understand exactly how the index crediting works. If you don’t, you could end up locked into a complex product with mediocre returns.

Alternative ‘safe haven’ investments in a recession

If annuities aren’t the right fit — or if you’re looking for other ways to diversify your retirement portfolio — here are other low-risk investments to consider during a market downturn.

• High-yield savings accounts: These accounts offer FDIC-insured protection and better interest rates than traditional savings accounts. They’re highly liquid, making them a smart place to park emergency funds or short-term cash.
• Certificates of deposit (CDs): CDs offer fixed interest rates over a set term, with higher returns than traditional savings accounts. While your money is locked up for the duration, they’re considered low-risk investments and are also FDIC-insured.
• Treasury bonds and TIPS: U.S. Treasury bonds are backed by the federal government and are one of the safest investments out there. Treasury Inflation-Protected Securities (TIPS) offer added protection against inflation.
• High-quality short-duration bonds: Bonds issued by financially strong companies or municipalities with short maturities (usually three years or less) are less sensitive to market swings. These can provide a reliable source of income with relatively low volatility.

All of these options can play a role in recession-proofing your portfolio, depending on your risk tolerance and income needs.

Bottom line

Annuities can offer some protection during a recession — if you choose wisely. Fixed annuities are the safest bet for low-risk income, while fixed index annuities might work if you’re willing to wade through complex terms. Variable annuities, though, aren’t great when stability is your top priority. 

That said, annuities aren’t your only option. Plenty of other investments can offer safety, income or both, often with fewer fees and more flexibility. Before committing to an annuity, speak with a fiduciary financial advisor. They can assess your current financial situation, help reduce risk in your portfolio and help you decide if an annuity is right for you.