Annuity Laddering Explained

With any retirement strategy, there are several variables needed to calculate the best retirement income for an individual.  Intangible concerns, such as peace-of-mind, also play a big role in retirement planning.  There is no magic formula to solve the retirement savings strategy dilemma.  However, the annuity laddering approach in retirement income planning is a strategy worth contemplating.

The Laddering Structure

With the laddering structure, multiple annuity contracts are strategically positioned for growth, inflation, mitigation, guaranteed interest, and income conversions.  In the recent past, this strategy has been extremely powerful.  For example, a 40% inflation rise from 1990 to 2010 meant that if a person had $100 in their wallet in 1990, that same $100 bill could only purchase $60 worth of “stuff” in 2010.

Annuity laddering is a strong solution to eliminating the concern of inflation and creates a long-term dependable strategy for the future.  This strategy also allows a person to live off of income and the ability to convert to a mixture of interest and principal in order to increase annual income when needed.  Finally, this strategy also allows for the principal to pass onto heirs when the time comes.

The Four and a Half Percent Rule

For those fortunate enough to have a tangible amount of wealth and are approaching retirement, the fear may not be the lack of money, but rather outliving the assets on hand.  Retirees are often more comfortable spending their retirement income rather than their retirement assets.  

The four and a half percent rule is used by some retirement planners as a way for a retiree to have income during retirement.  This rule states that a couple can withdraw 4.5% of their retirement capital and not outlive their income.  However, some retirees are afraid that their portfolio will not make enough to support their income or that they will outlive their assets.  Others fear that if they don’t withdraw enough, they will have robbed themselves of a happy retirement by being too conservative.  Annuity laddering addresses both of these fears.

The Strategy

Since a retiree that is worried about finances during retirement is not a happy retiree, converting assets into a guaranteed income can turn worry into elation.  The psychology of living within a known income amount makes minds more at ease than the thought of spending down assets for an unknown period of time.  Therefore, the strategy is to take a portion of retirement assets and purchase a fixed annuity for a steady income stream.  

Annuity income can be structured to begin immediately or deferred until a later date.  It can also pay income for a person’s life or for a particular number of years.  The option even exists to have the annuity pay after a person’s death to their spouse for a certain period of years.  With all of these flexible options, crafting a retirement income strategy can bring stability of income and peace of mind.  

The Keys to Laddering

There are four keys to laddering annuities.  

  1. Ladder the purchase of annuities—Investing in annuities that begin and end at different times is similar to the bond laddering strategy.  For those receiving interest payments from employment or other sources, when interest rates are low as they have been in recent years, investing in a deferred annuity is one way to build up wealth before or during retirement.  With a deferred annuity, there is no need to purchase annuities yearly since most deferred annuities credit interest at current rates.  

Another positive aspect of deferred annuities is the option as to how the money will be distributed.  Using this type of strategy allows for peace of mind knowing that income can be replaced if a particular income source is lost during retirement, such as an interest buyout in a company.

  1. Ladder the payout of annuities—Targeting multiple payout periods is another strategy of retirement planning.  For example, if a retiree expects to travel extensively and spend considerably more money yearly from age 65 to 75 as opposed to 75 and beyond, then capital can be used to purchase an annuity that would pay out a significant income stream for those 10 years.  Another annuity could also be purchased that would begin at age 75 and continue for the remainder of life.
  2. Annuities as a safety net—Health care costs is one of the most common concerns for retirees.  Long-term care facilities can quickly eat up a retiree’s savings.  While annuities are not designed to replace Medigap or long-term care insurance, they can provide a retiree with an income safety net.  A deferred income annuity allows for money to be put away now, then drawn out a fixed income for a set number of years at some point in the future.  Owners cannot change or surrender the annuity, but this means that they also receive a higher payout in the future.
  3. Conversion of assets into annuities—Recently, the Treasury Department issued financial regulations that changed the minimum distribution rules.  Annuity investors can now start collecting at a later date.

This means that a 401(k) can be paid out in the form of an annuity for life.  Life insurance that carries a cash value can also be exchanged, tax-free, for an annuity if the insurer feels that they no longer need the death benefit.  Likewise, a Roth IRA can also be converted into a flow of tax-free payments for life.

With so many different ways to purchase and manage annuities, any type of scenario that has a retiree or potential retiree worried can be crafted to alleviate these worries.  Deciding how to live during retirement, what goals are to be sought, and how much income it will take to reach those goals is the first step in deciding if annuity laddering is the best option.  However, with all of the benefits connected to laddering annuities and the overall peace of mind that it brings, retirees should definitely consider taking some of their retirement savings and investing in annuities.  They have nothing to lose but worries about the future.

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