Annuities: The key to unlocking financial security in retirement

Many look forward to their retirement as a time of well-deserved rest and recreation. However, in a time of economic uncertainty and market unpredictability, it is natural to ask the question: What am I doing to protect myself from the possibility that I might run out of money later in life?

This concern is especially acute given that the span of retirement is lasting longer than ever. According to research, longevity after age 65 has increased by about a year per decade. Half of men reaching 65 now live to at least 85, and half of women to at least 88, meaning retirement can possibly last 20–30 years. This challenge is amplified by the “Peak 65” phenomenon—the largest wave of Americans in history reaching age 65—creating unprecedented pressure on retirement systems and personal savings.

Moreover, for the past several decades, the decline of traditional defined benefit pension plans has shifted the responsibility for retirement security from employers and governments to individuals. This has coincided with an increase in life expectancy, creating a perfect storm for longevity risk—i.e. the possibility of outliving one’s savings. Public pension systems, originally designed for shorter retirements, are under strain as people live longer, while corporate pensions have largely been replaced by defined contribution plans such as 401(k)s, which place investment and longevity risk squarely on individuals.

Given these challenges, retirees are increasingly exploring tools and strategies beyond traditional pensions that can help safeguard their financial security throughout a longer retirement.

4 ways to help reduce longevity risk

Delaying Social Security benefits is one way retirees can reduce longevity risk. While benefits can start at 62, full retirement age is 66–67 and waiting beyond that can boost payments by about 7%–8% per year until age 70, plus cost-of-living adjustments. This delay often results in higher lifetime benefits, making it an attractive strategy for those who can afford to wait. However, retirees with limited savings or high withdrawal needs may need to claim their benefits earlier to maintain financial stability.

Implementing a sustainable withdrawal strategy can also help in preserving retirement savings over the long term. Approaches such as the 4% rule—which suggests withdrawing 4% of your portfolio in the first year of retirement and adjusting for inflation thereafter—provide one potential framework for maintaining income without depleting assets too quickly.

Additionally, products such long-term care insurance may help cover costly services like nursing homes or in-home care, which can exceed $100,000 annually. These expenses often arise late in life, when retirement savings may already be depleted.

Another insurance product that could potentially mitigate longevity associated risk is annuities. An annuity is an insurance contract designed to convert a lump sum or series of payments into a steady income stream, often for life. While annuities can be expensive, they may help address longevity risk—the possibility of outliving one’s savings—by providing guaranteed payments regardless of market conditions.

How do annuities work?

Annuities come in several types, each designed to address different goals and risk levels. Fixed annuities offer guaranteed interest and predictable income, potentially appealing to conservative investors seeking stability and protection from market volatility, though with limited growth potential. Variable annuities tie returns to investment performance, offering higher growth and inflation protection but exposing investors to market risk. Indexed annuities provide a minimum guaranteed return plus gains linked to a market index, balancing growth potential with downside protection through caps and participation limits. Choosing the right type depends on your individual risk tolerance, income needs and long-term objectives.

Annuities may also potentially be used to help retirees manage one common behavioral pitfall in investing: emotional reactions to market volatility. Those retirees who rely solely on market-based withdrawals can be more vulnerable to “sequence-of-returns risk,” where poor market performance early in retirement can force them to reduce spending or sell assets at a loss. By providing a guaranteed income stream, annuities can help to reduce this pressure, allowing retirees to maintain their lifestyle without making panic-driven decisions during downturns. Depending on the type of annuity, this stability can help preserve long-term portfolio health and reduce the likelihood of locking in losses during market stress.

Ultimately, annuities are not a one-size-fits-all solution. But when thoughtfully integrated into a retirement plan, they can potentially help address specific risks and reduce financial stress. Because every retiree’s situation is unique, consulting a qualified financial advisor is also essential. Advisors can assist in tailoring a plan that integrates income sources, tax-efficient withdrawals, and contingency strategies, to help ensure that retirement savings remain resilient and allow retirees to enjoy their golden years with greater freedom and security.

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Joe Toledano is managing director, head of insured solutions with Morgan Stanley Wealth Management. Contact him at [email protected].