A retirement portfolio can earn a perfectly reasonable average return and still run into trouble. The problem is not always how much the market earns over 20 or 30 years. Sometimes, it is when the good and bad years arrive.
A major market decline just after retirement can be especially damaging because retirees are usually withdrawing money at the same time their investments are losing value. Selling more assets after a downturn leaves fewer shares available to participate when markets eventually recover.
This is known as sequence-of-returns risk.
Understanding how variable annuities help manage retirement sequence risk starts with separating investment growth from retirement income.
Variable annuities can maintain exposure to stocks, bonds, and other investments while certain contracts offer lifetime withdrawal or income guarantees.
Investor.gov notes that some variable annuities allow annual withdrawals for life regardless of market performance under specific contractual conditions.
These guarantees do not eliminate market losses, but they can reduce how much retirement spending depends on selling investments at bad times.
What Makes Sequence Risk So Dangerous?
Sequence risk is the danger that investment losses occur early in retirement while regular withdrawals are already reducing the portfolio.
Consider two retirees starting with identical portfolios and taking the same annual withdrawals. Both could earn the same average return over 20 years but finish with dramatically different balances if one experiences poor returns during the first several years.
Morningstar illustrates this effect with a simple example. A portfolio beginning at $10,000, making $1,000 annual withdrawals, and experiencing the same three annual returns in different orders ends with different balances simply because the negative return comes earlier in one scenario.
The problem becomes more serious with larger portfolios and longer retirements.
Recent Morningstar research continues to identify the opening years of retirement as especially important. Early losses combined with withdrawals can damage the portfolio’s ability to support spending decades later.
That makes managing cash flow during weak markets just as important as choosing investments.
Variable Annuities Separate Income From Pure Market Performance
A variable annuity typically invests money through subaccounts that may hold stocks, bonds, money-market instruments, or diversified portfolios.
Those investments still fluctuate.
If the stock market falls sharply, the contract’s investment value can decline as well. A variable annuity is not automatically a protected investment account.
The difference is that certain contracts add insurance features on top of the market-based portfolio.
Investor.gov explains that variable annuities may provide features allowing owners to withdraw up to a specified amount each year for life. Optional living benefits can include guaranteed lifetime withdrawal benefits, minimum income benefits, and minimum accumulation guarantees.
That creates two different layers.
The investment account continues moving with markets, while the insurance feature may establish a contractual income framework.
For a retiree worried about a market crash shortly after leaving work, that separation can be valuable.
Lifetime Withdrawal Riders Can Create an Income Floor
One of the most relevant features for sequence-risk management is the guaranteed lifetime withdrawal benefit, often shortened to GLWB.
Under qualifying contract terms, the rider may allow a specified level of annual withdrawals for life even if poor investment performance eventually reduces the account value substantially or to zero.
Investor.gov gives an illustrative example of a living benefit permitting withdrawals of up to 6% of purchase payments annually for life regardless of market performance. Actual percentages and rules differ widely between contracts.
Imagine a retiree needs $60,000 annually.
Social Security covers $30,000, and a variable annuity rider provides another $18,000 of contractual lifetime income. Only $12,000 of basic spending now needs to come from other investments.
If stocks fall 25%, the retiree may therefore need to sell far fewer outside investments than someone funding the entire $30,000 gap directly from a portfolio.
The annuity has not prevented the market decline.
It has reduced the amount of spending exposed to that decline.
Guaranteed Income Can Reduce Forced Selling
Forced selling is one of the main mechanisms through which sequence risk damages a retirement portfolio.
Suppose a $700,000 portfolio falls 20%, leaving $560,000.
A retiree who still needs to withdraw $40,000 is now taking more than 7% of the reduced balance. Once those assets are sold, they cannot participate in a subsequent recovery.
Guaranteed annuity income can reduce that pressure.
If dependable income already covers most essential expenses, retirees may be able to delay large withdrawals from market-based investments until conditions improve.
This idea is similar to other sequence-risk strategies.
Morningstar discusses cash reserves, balanced portfolios, and flexible withdrawal policies as ways of reducing the need to sell depressed assets. Vanguard likewise notes that dynamic spending can help mitigate sequence risk by reducing portfolio withdrawals during weak markets.
Variable annuities provide another possible tool: shifting part of the spending obligation away from portfolio liquidation and toward contractual income.
The Investment Allocation Still Matters
Income guarantees do not make the underlying investment strategy irrelevant.
Variable annuity subaccounts still determine much of the contract’s investment performance.
Someone holding an aggressive equity allocation may experience much greater account-value volatility than someone using a diversified mix of stocks and bonds.
Morningstar’s retirement research has repeatedly shown that portfolio composition influences exposure to sequence risk. Its analysis notes that all-equity portfolios are particularly vulnerable because stocks experience wider fluctuations than balanced portfolios.
A variable annuity can therefore still benefit from thoughtful asset allocation.
The objective is usually not to eliminate equities. A retirement lasting 25 or 30 years may require growth to help offset inflation.
Instead, investors can balance growth potential with the amount of short-term volatility their income strategy can realistically handle.
Some annuity riders may also require assets to remain within specified investment options. Investor.gov warns that these restrictions can limit investment returns and should be understood before purchasing the benefit.
Income Guarantees Come With Costs
Protection against sequence risk is not free.
Variable annuities may charge mortality and expense risk fees, administrative costs, underlying fund expenses, surrender charges, and additional fees for optional living benefits.
Investor.gov specifically notes that optional insurance features carry additional charges and that all variable annuity expenses reduce account value and investment returns.
FINRA also notes that rider costs can represent a significant portion of an annuity’s total expense structure.
Suppose a guaranteed withdrawal rider adds another 1% annual cost to a contract.
The guarentee may reduce retirement income uncertainty, but the additional fee also lowers the net return available for long-term compounding.
That creates a trade-off.
A retiree with very limited guaranteed income may find the added protection extremely valuable. Someone whose Social Security and pension already cover nearly all essential expenses may gain much less from paying for another income guarantee.
Sequence-risk protection should therefore be evaluated based on the actual problem it solves.
Large Withdrawals Can Weaken the Protection
Having a lifetime withdrawal benefit does not mean retirees can take unlimited amounts from the contract without consequences.
Most riders have detailed rules.
Investor.gov warns that large withdrawals can significantly reduce certain optional benefits. Some features may also require investors to maintain specific asset allocations or meet other conditions.
For example, suppose a rider supports $20,000 of contractual annual income.
If the retiree suddenly takes an additional $100,000 withdrawl for a property purchase, the future guaranteed benefit may be reduced, depending on the contract.
That can weaken the very protection being used against sequence risk.
This is why emergency reserves are still important even when someone owns an annuity.
The annuity can provide one layer of income protection while cash and other liquid assets provide flexiblity for large unexpected expenses.
Variable Annuities Should Complement Other Retirement Tools
A variable annuity is not the only way to manage sequence risk.
Cash reserves, high-quality bonds, flexible spending, delayed major purchases, diversified portfolios, and other guaranteed income sources can all help.
Morningstar highlights approaches such as holding one or two years of anticipated withdrawals in cash, maintaining diversified fixed-income exposure, and adjusting withdrawals after poor market performance.
Vanguard similarly emphasizes dynamic withdrawal strategies rather than allowing short-term market conditions to completely dictate retirement spending.
An annuity can sit alongside these strategies.
For example, Social Security and annuity income might cover housing, food, insurance, and utilities. A diversified investment portfolio could then fund travel and other discretionary expenses.
During a severe bear market, optional spending can be temporarily reduced while the guaranteed-income layer continues covering necessities.
That makes the overall retirment system more resilient without requiring every dollar to be annuitized.
Sequence Protection Is Not the Same as Eliminating Risk
Perhaps the most important distinction is that a variable annuity does not make sequence risk disappear.
The underlying portfolio can still fall.
Inflation can reduce the purchasing power of fixed income. Rider fees reduce returns. Large withdrawals may weaken guarantees, and contractual benefits depend on the insurance company responsible for paying them.
Investor.gov advises investors to consider the insurer’s financial strength, the conditions attached to guarantees, ongoing fees, investment restrictions, and how an annuity fits into the broader financial plan.
The objective is therefore risk management, not risk elimination.
A well-designed variable annuity can transfer part of the retirement-income problem to an insurer while leaving other assets invested for growth.
That can be particularly valuable during the dangerous early years of retirement, when preserving the portfolio’s ability to recover may matter most.
Sequence-of-returns risk can turn an otherwise reasonable retirement portfolio into a fragile one when large market losses arrive during the first years of withdrawals.
Variable annuities can help manage that problem by combining market-based investments with optional lifetime-income guarantees. A dependable withdrawal floor may reduce the need to sell other investments during downturns, giving the broader portfolio more time to recover.
The protection comes with trade-offs, including rider costs, investment restrictions, surrender provisions, and limits on excess withdrawals.
Before purchasing a variable annuity, calculate how much essential spending is already covered by Social Security or pensions, estimate the remaining income gap, and compare the cost of an annuity guarantee with other sequence-risk strategies.
The goal is not to avoid every market decline – it is to make sure a bad market does not force a bad retirement decision.
