Robert A. Di Ieso, Jr.
By Sarah Max
November 2, 2015

Q: I’m retired and have $1,000 to $3,000 left over each month in income. I have a pension, Social Security, and a lifetime annuity from investments. I put $1,000 per month into a personal annuity, with 60% going into a stock index account and 40% into a fixed account. Is there a better place to put this money? — Richard

A: As far as retirement predicaments go, this is a great one to have.

Without knowing all the details — including your age, health, current expenses, and so on — it’s hard to say what exactly you should do with your excess retirement income. The specifics depend on whether you are stockpiling for future generations, worry that your expenses will eventually come in line with your income, or simply want the peace of mind that you have more than you need, come what may.

That said, you (and your heirs) may be better served if you put this surplus in a taxable account rather than contributing any more to an annuity. “I don’t see a lot of advantages to saving in an annuity in this case,” says Herb White, a certified financial planner and founder of Life Certain Wealth Strategies in Greenwood Village, Colo. “This is especially true for someone who already has a few sources of stable retirement income.”

Annuities can be a useful tool to save additional money for retirement and, depending on the type of annuity, convert your savings into a predictable stream of income.

Tradeoffs can include high fees, less flexibility and taxes. Taxes are a big one, says White, especially since the benefits of tax-deferred growth likely won’t be as powerful at this stage of the game.

That’s because any earnings in the annuity are taxed as ordinary income. If you’re in the 25% or 35% marginal tax bracket, that’s the difference between paying 25%-35% versus 15% for long-term capital gains rate for a taxable account.

Likewise, annuities aren’t an ideal vehicle for transferring wealth to the next generation.

With a taxable account, the “basis” (what you paid for the security plus related expenses) resets when you pass away. In other words, when your heirs sell those securities down the road, the capital gains is based on the value of the securities when they inherited them, rather than when you bought them.

That isn’t the case with an annuity. “There is no step-up basis, making it one of the least efficient ways to transfer wealth,” White adds.

If not an annuity, then what?

If you haven’t already done so, use your excess income to build your cash reserves — set aside up to a year’s worth of expenses — and pay off any debt.

Next, take a look at your projected retirement income and expenses. If this time of abundance seems to be temporary, then by all means keep saving, but in a taxable account.

Not knowing your specifics, it’s hard to say exactly how these funds should be allocated, but your 60% stock/40% bond split is probably on target, says White, as long as you’re well diversified across companies of all sizes and have some exposure to real estate investment trusts (REITs), dividend-paying stock, and preferred stocks.

On the bond side, take a look at defined-maturity exchange-traded funds, says White. These relatively new ETFs are a cost-effective way to access bonds that have the same or similar maturities but are diversified across different credit qualities, industries, etc.

By creating a portfolio that essentially comes due at around the same time, these ETFs give investors some assurance of the return of their investment at a known date — similar to an individual bond and unlike conventional fixed income funds. “This is one way to reduce some interest-rate risk,” says White.

If you feel confident that you have more than enough to get you through your golden years, consider passing down some of this excess to your heirs today. You can gift anyone up to $14,000 per person, per year without running into the gift tax.

While there aren’t a lot of great tax-friendly vehicles for saving when you’re already in retirement, you can help your children or grandchildren maximize their contributions to their own retirement funds or college savings plans.

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