Key Takeaways
- Annuities can be effective tools for high-net-worth individuals, thanks to several appealing and unique features.
- There are strong tax advantages tied to annuities, including their ability to grow tax-deferred and that they are not subject to the same contribution caps that limit 401(k)s and IRAs.
- The safety of an annuity is also a major advantage to high-net-worth individuals, helping them balance out risk in other parts of their portfolio.
How Annuities Can Fit Into Your Portfolio
Your overall wealth along with how much money you are looking to invest will help determine if an annuity makes sense as part of your portfolio.
Annuities are often used as a safe and effective way to guarantee income in retirement. For this reason, they may not make sense as part of a strategy for the ultra-wealthy (think those with net worths in the tens of millions or higher).
“The very wealthy probably don’t need annuities,” Rob Williams, managing director at the Schwab Center for Financial Research, told Annuity.org. “They may have enough money just to support their retirement without needing to buy annuities. Annuities are a form of insurance.”
But for high-net-worth individuals, there are plenty of ways that buying an annuity can fit soundly and efficiently into your portfolio.
For individuals with assets well over $500k, you will have better flexibility in structuring for retirement.
It may not be necessary for you to focus only on income planning. Once you retire and the paychecks cease, there may not be as large of an income gap as with middle-class investors, or those who have saved $50k to $350k to fund their retirement lifestyle.
How Annuities Can Benefit High Net Worth Individuals
- Diversification
- Tax advantages
- Inflation protection
- Legacy
Annuities are just as viable for high-net-worth individuals as they are for the average consumer. They provide protection, peace of mind and a guaranteed income, which is valuable regardless of your net worth. This is especially true for individuals with significant wealth tied up in private or very risky ventures. Creating a minimum level of income insulates a retiree from needing to take withdrawals at an inopportune time.
Stephen Kates, CFP®Principal Financial Analyst for Annuity.org
Stephen Kates, CFP® is a personal finance expert specializing in financial planning and education. He serves as the Principal Financial Analyst for Annuity.org, where he delves into industry trends to support consumers and financial advisors on wealth management, annuities, retirement planning, and investing.
Diversifying Your Portfolio
High-net-worth individuals are often well-versed in the importance of having a strong and diversified portfolio.
“A diversified portfolio has historically been the best hedge against inflation and provides the best opportunity to have your savings, as well as your income, keep pace with or exceed inflation,” Williams said.
Buying an annuity is one effective way to help further that diversification. Annuities are not investments themselves but are actually insurance products, which require you to hand over money that can eventually be converted into guaranteed payments.
This built-in safety — while still maintaining the ability to grow in value — can add some much-welcomed security to your portfolio while still providing predictable income.
Annuities can also help combat inflation by creating streams of guaranteed income set to begin later in life. If you buy multiple annuities and ladder them, you can create a system where you receive more and more payments as you age and inflation grows.
Williams pointed specifically to the idea of marrying an annuity with an existing portfolio to best combine the benefits of your different investments and what each tool does best.
Pro Tip
Laddering annuities involves buying multiple annuities but at different times to take full advantage of market conditions.
The Tax Advantages of Annuities
Part of building a strong portfolio is finding the best ways to make taxes work in your favor. Annuities help tremendously.
Many types of annuities have great tax features that are beneficial to high-net-worth individuals. According to the Insurance Information Institute, if you purchase a deferred annuity, then your taxes will be deferred until you begin making withdrawals.
This includes interest earned on the annuity, making it an effective savings vehicle that can grow without being limited by taxes.
Did You KNow?
Due to tax deferral, you may be in a lower income bracket when the taxes on your annuity are due than you were when you were accumulating value.
Source: Wisconsin Office of the Commissioner of Insurance
High-net-worth individuals can also employ annuities to circumvent a common limit on their savings: contribution caps.
Common retirement plans such as 401(k)s and IRAs are subject to contribution limits, meaning, you can only contribute a certain amount to your plan in a given year.
Annuities, on the other hand, do not have to abide by these caps. If you are already maxing out your traditional retirement plan savings, then an annuity can be used to help you put even more away.
Adding Safety and Principal Protection to Your Portfolio
Your portfolio may already contain a significant amount of risk, which is often necessary to grow your investments.
That’s why a major appeal of annuities to high-net-worth individuals is their perceived safety. While there is always some level of risk associated with annuities, the primary concerns are liquidity risk, where the money is inaccessible, or inflation risk, where inflation outpaces annuity growth. Annuities, however, are protected from market risk. Overall, annuities tend to be a much more secure option than some other forms of investments.
What Makes Annuities So Safe?
- Your principal investment is protected.
- Annuities result in guaranteed payments.
This is the case for a couple of different reasons. First off, your principal investment is generally protected when you buy an annuity. Unlike other traditional investments, you don’t have to worry about losing all the money you placed into the product.
Additionally, annuities result in guaranteed payments that can last for the rest of your life. Depending on the type of annuity you have, those payments may fluctuate based on the performance of investments.
But you are always guaranteed to get something and can rest easy knowing those payments will never end.
There is a drawback to achieving this security that high-net-worth individuals should be aware of, and it is that annuities tend to be illiquid products. It can be difficult to get your money out of an annuity if you change your mind down the road, and you may be subject to surrender fees.
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Leaving a Legacy For Your Beneficiaries
High-net-worth individuals can use annuities to help leave a strong legacy for their beneficiaries. This can be accomplished in a few different ways, and there are a couple reasons why annuities are particularly effective at this.
When you purchase an annuity, you can set it up with a death benefit rider, allowing it to pass to your named beneficiary after you die. For those worried about the illiquidity that comes with purchasing an annuity, it can help to know that the remaining value of the contract will not be lost when you die.
Did You KNow?
Annuities generally do not have to go through probate when being transferred to a beneficiary.
One reason that annuities are strong vehicles for providing for your beneficiaries is that they are often not subject to probate. Circumventing this step allows the annuity to pass straight to your beneficiary without any hassle.
High-net-worth individuals also do not have to be the center of an annuity they purchase. You can buy an annuity directly for your child, setting it up so that they eventually receive those payments.
Creating an annuity for your child can help give them a leg up in life with regular guaranteed payments while also removing the risk of them quickly burning through a lump sum.
