Should I use an annuity as part of my retirement income strategy? Replacing the income you are used to in retirement can be complicated. 

You’ve likely spent decades building wealth, investing wisely, and working toward financial security. But as retirement nears, the question becomes: how do you turn your assets into sustainable income for the next 20, 30, or even 40 years plus? 

For high net worth and high earning individuals, annuities can seem like an attractive option for creating predictable income, but are they the right choice for you?

In this insight, I’ll discuss the advantages and disadvantages of using an annuity in your retirement plan and help you figure out if it fits into your overall strategy.

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What Is an Annuity?

An annuity is essentially a contract between you and an insurance company. You invest a lump sum or make a series of payments, and in return, the company guarantees to provide you with income for a specified period, often for life.

There are several types of annuities, including:

• Fixed annuities: Provide a guaranteed, steady payout.
• Variable annuities: Payouts fluctuate based on the performance of the investments within the annuity.
• Indexed annuities: Payouts are tied to the performance of a stock market index, like the S&P 500.
• Immediate annuities: Start paying out almost immediately after you make your investment.
• Deferred annuities: Allow your money to grow tax-deferred before you start receiving income.

Why High-Earners Consider Annuities

For many high-net-worth individuals, the appeal of an annuity is simple: it promises guaranteed income for life. When you’ve worked hard to accumulate wealth, the last thing you want is to worry about outliving it. 

This peace of mind can be especially valuable for those who want to lock in a portion of their income and not rely solely on market performance.

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The advantages of Using Annuities in Your Retirement Strategy

1. Guaranteed Income for Life

Annuities can provide a sense of security by ensuring you won’t outlive your money. Let’s say you’ve already maxed out your Social Security benefits and you want to cover the rest of your living expenses. An annuity can supplement this by creating another steady, predictable income stream.

I’ve worked with clients who are conservative when it comes to market risk. For example, a high earning executive that has a substantial portfolio of stocks and bonds but is anxious about volatility as they approach retirement. 

We can discuss using a portion of your assets to purchase a deferred annuity, which allows you to establish future income and relieve your stress about the market’s ups and downs.

2. Tax-Deferred Growth

If you’ve maxed out other tax-advantaged accounts, like IRAs and 401(k)s, a deferred annuity allows your investments to grow tax-deferred. You won’t owe taxes until you start withdrawing funds, which can be a big advantage if you’re still working or earning substantial income.

For high earners, this means you can build up even more retirement assets without triggering higher taxes today. When you’re in your peak earning years, avoiding unnecessary taxes is always a win.

3. Longevity Risk Protection

One of the biggest risks in retirement is outliving your money, especially if you’re in good health and could live into your 90s and later. Annuities are designed to protect against this risk by providing a guaranteed income stream for life.

This type of “longevity insurance” can give you peace of mind, knowing that no matter how long you live, your basic expenses will be covered. For those who don’t have pensions, an annuity can serve as a private pension like income source.

4. Customizable to Your Needs

Annuities come with a wide range of options, making it possible to tailor the contract to your specific needs. Want income for a set period (say, 10 or 20 years)? 

You can arrange that. Want to leave something behind for your heirs? Some annuities offer death benefits, which allow your beneficiaries to inherit unused funds.

When I think about clients who have special financial needs, like providing for a spouse or adult children, an annuity’s flexibility can be a strong selling point. It’s not a one-size-fits-all product, which means you can customize it to suit your goals.

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The Drawbacks of Annuities

1. Liquidity Issues

One of the biggest downsides to annuities is the lack of liquidity. Once you commit money to an annuity, it’s typically locked up for a set period. If you need access to the funds earlier, you could face steep penalties, known as surrender charges.

If you like to have flexibility with your investments, annuities may not be the best fit. They’re designed for long-term income, not quick access to your cash.

2. Fees and Costs

Annuities can come with a laundry list of fees, management fees, mortality and expense risk charges, and other hidden costs. If you opt for a variable annuity, investment management fees can eat into your returns, which could leave you with less income than expected.

For high-net-worth individuals, these costs can add up quickly and may not be worth the trade-off, especially when other investments, like stocks or bonds, can offer more growth potential without the hefty price tag.

3. Inflation Risk

While annuities provide guaranteed income, not all of them are inflation adjusted. Over time, inflation can erode the purchasing power of your fixed payments, which could leave you with less real income in the later years of retirement.

Imagine locking in a $50,000 annual income now, only to realize in 20 years it doesn’t cover nearly as much. An inflation-adjusted annuity is one solution, but these often come with lower initial payouts or higher costs.

Interested in knowing how your future income needs will be affected by inflation? The following inflation calculator will help you.

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How Annuities Compare to Other Retirement Income Options

Annuities are just one tool in your retirement planning toolbox. To decide whether they make sense, it’s helpful to compare them to other options.

1. Dividend-Paying Stocks

For high earners, dividend paying stocks offer the potential for growth and income, and they’re more flexible than annuities. You can easily sell your stocks if needed, and the dividends provide income that often grows over time. 

However, stocks come with market risk, and dividends aren’t guaranteed. This is usually a viable option for someone that has accumulated a great deal of company stock and those shares are paying dividends.

For example, if you own 75,000 shares of “ABC123” stock and those shares receive an average dividend of $.15 per share on a quarterly basis you would receive $45,000 annually. 

This is from the dividends alone and coupling this with social security and other investments, you will begin to cover your expenses in retirement.

2. Bonds

Bonds are another low risk option, providing fixed income without the complexity of annuities. Municipal bonds, in particular, can offer tax advantages. 

However, interest rates are historically low, and the income from bonds may not keep up with inflation or provide enough growth for high-net-worth individuals.

3. Real Estate

Real estate can provide a steady income stream and potential appreciation. If you’re comfortable with being a landlord or investing in REITs, real estate can be a great way to diversify your portfolio. 

However, it’s not as passive as an annuity, and there’s still some level of market risk.

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Who Should Consider an Annuity?

1. Risk-Averse Individuals

If you’re someone who prefers stability over market volatility, an annuity might be a good fit. The peace of mind that comes with guaranteed income can outweigh the downsides for those who value security above all.

2. High-Net-Worth Individuals Looking for Longevity Insurance

Annuities are particularly useful for those who want to ensure they don’t outlive their savings. If you’ve already built a large portfolio but are concerned about longevity risk, allocating a portion of your assets to an annuity can provide a layer of protection.

3. Those Without Other Guaranteed Income Sources

If you don’t have a pension or other sources of guaranteed income, an annuity can serve as a personal pension. It provides the steady cash flow you might be missing from other parts of your retirement plan.

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When an Annuity Might Not Be Right for You

1. If You Have Sufficient Income Sources

If you already have reliable income from other sources, such as Social Security, pensions, or dividends, you may not need the added complexity or cost of an annuity.

2. If You Value Flexibility

Annuities can tie up your capital for years, making them a poor fit if you prefer more liquid investments. For those who anticipate needing access to their funds, stocks, bonds, or real estate may offer better options.

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Key Factors to Consider Before Purchasing an Annuity

Before deciding on an annuity, it’s important to evaluate:

• Costs vs. Benefits: Weigh the fees against the income you’ll receive.
• Longevity: How long will you need income?
• Portfolio Balance: Does an annuity complement or duplicate other investments?
• Tax Implications: How will annuity income impact your taxes?

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What’s Next: Is an Annuity Right for You?

Annuities can be a valuable tool in creating a retirement income strategy, especially for high-net-worth individuals who are looking for guaranteed, lifelong income. However, they come with trade-offs, such as liquidity and fees. 

Whether an annuity is right for you depends on your specific financial goals, risk tolerance, and overall retirement plan.

Get Professional Guidance

Before purchasing an annuity, it’s important to speak with a trusted financial planner who can help you navigate the complexities of these products. 

If you’re unsure whether an annuity fits into your retirement strategy, schedule a consultation to explore your options and make informed decisions.