Many investors are familiar with bond ladders or CD ladders, and might already have these types of strategies in their retirement plan. Laddering annuity contracts is a new concept to most people, but you should definitely be aware of these unique strategies for both lifetime income and principal protection.
Let’s take a look at the pros and cons of laddering annuities, and specific laddering strategies that I currently recommend to my clients.
Laddering for Yield
Bond and CD (Certificate of Deposit) ladders try to achieve an overall higher yield by staggering maturities so that you have money maturing at different time intervals. The hope is that when a specific tranche of money matures, you can lock that money into a higher rate for another specific period of years.
Multi-Year Guarantee Annuities (MYGAs) are the annuity industry’s version of a CD. You lock in an interest rate for a specific period of time that you choose. Both have no annual fees and no moving parts, and the interest rate is contractually guaranteed. MYGAs are also referred to as “Multi Year Guaranteed Annuities” and “Fixed Rate Annuities.” MYGAs are also as close as you are going to get to a bond, where you are able to peel off interest and not touch the principal.
Fixed Rate Ladder
The most popular annuity laddering strategy for yield is what I call a “Fixed Rate Ladder.” For example you would split a $300,000 total, and purchase $100,000 in a 3 Year MYGA, $100,000 in a 4 Year MYGA, and $100,000 in a 5 year MYGA.
Starting in year 3, you would have money maturing annually to hopefully move to a higher rate. You are staggering annuities over a period of time.
Mixed Fixed Ladder
Another annuity laddering illustration is what I call a “Mixed Fixed Ladder.” It’s the same duration staggering strategy as the “Fixed Rate Ladder” mentioned above, but both MYGAs and Fixed Indexed Annuities (aka: Fixed Index Annuities, FIAs, or Indexed Annuities) are used together.
Even though it is too often promoted as a market return strategy, FIAs are life insurance products and issued as fixed annuities. FIAs were introduced in 1995 to compete with CD returns, and that’s what they have historically done. So combining FIAs and MYGAs is a unique CD return laddering strategy to consider.
For example, with a $400,000 total, you would put $100,000 into a 3 year MYGA, a 5 year MYGA, a 7 year FIA, and a 10 year FIA. The MYGA yield is contractual, and the hope is that the FIA returns will be a little higher than comparative duration CDs. Both fully protect your principal.
Laddering for Lifetime Income
So now you know that annuities can be laddered for yield, but they can also be laddered for income. Annuities are the only financial product on the planet that can guarantee a lifetime income stream regardless of how long you live. It’s a transfer of risk strategy and financial monopoly that only annuities have.
An “income annuity” is primarily based on your life expectancy at the time you start the payments, with interest rates playing a secondary role. Income annuities (aka: lifetime annuity) provide a guaranteed fixed income stream for life and can contractually bring needed cash flow and a guaranteed income floor that combines with your Social Security benefits and pension (if so fortunate).
There is no “best laddering income annuity strategy” out there, so let’s look at 3 of the most popular ones currently being used.
Ladder the Purchase
Laddering the purchase of annuities makes sense if you are close to retirement or don’t want to commit to a large lump sum. For example, if you had in mind to place $300,000 into a Single Premium Immediate Annuity (SPIA), you could buy a $100,000 SPIA every year for 3 consecutive years.
Ladder the Start Date
You can also ladder the income start date. For example, taking that same $300,000 example to place in a SPIA, you could buy 3 separate $100,000 annuities at the same time with different income start dates. The first $100,00 SPIA would have income start in 30 days from the policy issue date. The second $100,000 SPIA would have income starting in 1 year, and then you would put $100,000 into a DIA (Deferred Income Annuity) with income starting in 2 years.
Deferred Income Annuities (DIAs) are the same simplistic structure as a SPIA, but once you defer a SPIA past one year….it turns into a DIA. Same product structure, but different start date rules.
This is a combination of laddering the purchase date and laddering the start date. For example, using a $300,000 example, you would buy a $100,000 annuity with income starting in one year. The second $100,000 annuity would be purchased a year later with income starting in 3 years. The third $100,000 annuity would be purchased in year 3 with income starting in 5 years.
The bottom line is that income annuity laddering is customizable to your specific situation and goals. And because annuities are contractual guarantees, it’s all math. The goal is to create the ladder to your specific needed parameters.
You Can’t Time It...So Don’t Try
Life insurance companies issue annuity contracts, and they have the big buildings for a reason. They don’t give anything away and they know when we are going to die!
When putting together your customized annuity ladder for income, know that the insurance company is going to base any lifetime annuity payouts on your life expectancy at the time the payments start. Interest rates play a secondary role. If you try to “time” your purchase or wait to build a ladder, you have to factor in the payments missed. In addition, if you let an annuity company hold on to the money long term before turning on the income stream, that carrier will enhance the payout.
The bottom line is that you can’t beat them, so don’t even try. If the contractual guarantees work for your situation, then you should consider transferring that risk to the annuity company.
By the way, all of these annuity laddering strategies can be used in Traditional IRAs, Roth IRAs, or non-IRA type accounts.
The Highest Number Wins….Always!
If you decide to buy an annuity, you might want to hedge your bets by exploring annuity laddering strategies. Remember that annuity quotes and contractual guarantees are like a gallon of milk. Unless you lock them in during the application process, they expire every 7 to 10 days.
It’s important to find an agent or advisor that uses an annuity quoting system that can transition into an annuity ladder calculator, and objectively looks at all carriers to find the highest number for your specific situation.
So go climb that annuity ladder. It just might make contractual sense.