Wealthy investors are wising up to the unique benefits of annuities. While these insurance-sold investment products are known as tools for turning savings into lifetime income, they are increasingly capturing the attention of high-net-worth investors as a way to maximize after-tax gains, leave more to heirs, offset the impact of inflation, and stabilize portfolios during a highly volatile time.
Annuities vary in type and purpose. A plain fixed annuity is similar to a certificate of deposit, paying a set yield for a specific period. A variable annuity is much like a 401(k), with underlying mutual-fund-like investments that grow tax-deferred. A registered index-linked annuity allows participation in a stock index’s return while putting a cushion under losses. And an income annuity turns a lump sum into a stream of guaranteed lifetime payments.
Annuities are complex and can charge high fees that erode benefits. But investors can also find inexpensive contracts with big potential advantages.
More Tax Deferral
Once you have maximized contributions to an IRA and 401(k), an investment-only variable annuity (IOVA) provides an opportunity for more tax-deferred investing. Gains grow tax-deferred and are subject to income tax rates when they are taken out. Any withdrawals prior to age 59½ are subject to a 10% penalty. Investors pay annual contract fees and expenses charged by underlying investments.
Some IOVAs are cheaper than the annual 0.5% to 1% charged by 401(k)s and they have no annual limits on how much is tax-deferred. For example, Equitable scrapped its annual fee this year on its Investment Edge Variable Annuity. Lincoln National Life’s Investor Advantage Variable Annuity charges 0.10% annually.
“IOVAs are great for holding tax-inefficient investments,” says David Lau, founder and CEO of DPL Financial Partners in Louisville, Ky., an online annuities marketplace for fee-only advisors, adding that contracts can be customized with private placement investments like hedge funds.
Minimize Taxes in Trusts
Tax rates on trust assets are notoriously burdensome: The top 37% income tax rate kicks in on income of $13,451.
By investing trust assets in low-expense passive funds within a cheap IOVA, they can grow tax-deferred—completely shielded from the trust’s onerous tax system—at a low annual cost, says Tim Muncie, head of RIA platform distribution and planning at Jackson, whose Elite Access Advisory Variable Annuity charges a flat $240 per year. That translates to 0.12% on a $200,000 investment or 0.024% on $1 million.
Stretch Inherited Assets
The Secure Act of 2019 eliminated one of wealthy families’ favorite legacy planning strategy: a so-called stretch IRA. Heirs were able to let inherited IRA assets continue to compound tax-deferred for their lifetimes. Under the new law, heirs must cash assets out within 10 years, severely truncating their potential value.
“But inherited nonqualified annuities can still be stretched out over heirs’ lifetimes,” Muncie says. “This can be a big win for large inheritances.”
More Ballast and Growth
Fixed annuities are hard to beat for investors looking for safety and yield. They protect principal and outperform other safe investments. In early October, Aspida Life Insurance Co. offered a fixed annuity with a five-year fixed rate of 5.3%, while five-year Treasuries paid 4.1% and the best five-year CD rates were around 4%.
As high-yielding principal protectors, fixed annuities can create the kind of portfolio stability traditionally provided by bonds, enabling investors to take more risk in other areas of their portfolios, says Matthew Liebman, founder and CEO of Amplius Wealth Advisors in Blue Bell, Pa., adding that healthy stock allocations are vital to offset the impact of inflation. “The number one reason we use annuities with wealthy clients is to raise the comfort level with having more equity exposure.”
This article appears in the December 2022 issue of Penta magazine