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My advisor is recommending putting over 50% of my portfolio in annuities. What say you?
– Georgia
As with most personal finance decisions, a lot hinges on the specific details of your situation. Fifty percent would likely be on the high side for most people, but that doesn’t mean it can’t be the right amount for you. Some may even want or need a larger portion of their portfolio in an annuity.
Let’s talk about the reasons you may want to put that much into an annuity, and the reasons someone may not want to. Compare these items to your own situation, goals and preferences and decide if 50% is the right amount.
Consider using this free tool to match with a financial advisor if you are interested in getting custom advice based on your circumstances and goals.
Guaranteed income is the fundamental reason to buy an annuity. While there are many types of annuities, an immediate annuity is the simplest and most straightforward variation. With a lifetime immediate annuity, you exchange a lump sum of money for a series of regular monthly payments. Much like a pension or Social Security benefits, lifetime immediate annuity payments last for the rest of your life.
With that in mind, let’s go over some of the main benefits of buying an annuity. The more these benefits appeal to you and make sense within the context of your financial plan, the larger your allocation toward an annuity may be.
When you receive income from an annuity, you don’t have to worry about outliving your savings, which is a significant concern for many retirees.
When considering how much of your portfolio you want to allocate to an annuity, think specifically about how much guaranteed income you need to cover your living expenses. This is known as an income floor. That way, if the market is poor and your investments don’t perform well, you can rely on that income floor to get you through.
However, if your Social Security benefits and/or pension payments already provide enough income to cover your living expenses, more guaranteed income may not be necessary. (But if you need an expert to assess your retirement income plan more closely, consider matching with a fiduciary advisor.)
A fixed annuity, meanwhile, pays a guaranteed interest rate regardless of how the stock market performs. Once your payments begin, they aren’t subject to the volatility of market fluctuations in the way that stocks, bonds, mutual funds and ETFs are.
If you have a very low risk tolerance and don’t like seeing your account value fluctuate, annuities can shield you from the emotional uncertainty of a volatile stock market. (And if you need help evaluating your risk tolerance and finding investments that match it, consider working with a financial advisor.)
So how much is too much when it comes to investing in annuities?
To determine whether it’s appropriate to put 50% of your money in annuities, it’s worth looking at some of the potential downsides to owning an annuity. If these drawbacks are significant in light of your goals and circumstances, you may not want to invest so much in an annuity.
When you hold money in a retirement account like an IRA, you can take withdrawals from the account whenever you want or need to. (Doing so before age 59 ½ can trigger early withdrawal penalties and taxes.) Once you annuitize, however, you lose the ability to access your balance since you’ve used it to purchase a series of regular payments from an insurance company.
So, consider how much liquidity you will have with the remaining 50% of your portfolio. Is it adequate to cover potential unexpected expenses? Are you comfortable with the size of the remaining balance? If you can answer yes to those questions then it may be okay to allocate half of your account to an annuity. If the answer is no, then you may want to reconsider.
If you purchase an annuity with money that you would have otherwise left invested, you give up future growth. Once annuity payments begin, they typically remain fixed. A 401(k) or IRA balance, on the other hand, will grow depending on the performance of the investments in your account. That higher balance may translate into higher payments down the road.
You can typically choose an annuity payout option that will leave a remainder benefit to an heir in the form of a reduced payment, such as 50%. However, you generally cannot leave a balance of money. Meanwhile, any money that’s in your retirement account when you die is left to your heirs.
The more you allocate toward an annuity, the less you will potentially leave to your heirs. Again, how much this matters to you is a personal decision. Your family and friends may be just fine without receiving an inheritance from you or perhaps you simply don’t want to leave them much. On the other hand, you may hope to leave more as part of your legacy, leading you to allocate less toward an annuity.
(But if you need help assessing your estate planning needs and how to structure your finances to meet them, consider finding a financial advisor with estate planning expertise.)
How much of your savings you should allocate toward an annuity is different for everyone. If you need more guaranteed income, are a conservative investor or aren’t concerned about leaving money to heirs, then placing more of your savings into an annuity can make sense.
To the extent those ideas don’t resonate with you, it’s probably a better idea to hold more of your money outside of annuities. Hopefully, your advisor explained their rationale for suggesting the amount they did. If not, you’re well within reason to ask. It’s a fundamental part of the advisor/client relationship.
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Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
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Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Brandon is not a participant in SmartAdvisor AMP, nor is he an employee of SmartAsset, and he has been compensated for this article.
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