Annuity Laddering
You’ve probably thought about CD ladders and Treasury ladders. But have you considered a ladder of annuities as a retirement income strategy? If you are baby boomer, maybe you should.
What is an Annuity Ladder?
Annuity laddering takes the strategy of using a fixed annuity and then spreading the risk around by using multiple annuity products.
Let’s assume that you have $300,000 that you are willing to invest into an immediate annuity for a lifetime income. If you bought a single annuity at age 65 today, you would probably receive a fixed monthly income for life in the range of $2050, with no benefits paid to beneficiaries.
Now assume that as an alternative, you are willing to spend more from savings now and purchase a smaller annuity. At age 65, you can buy a lifetime annuity for $100,000 and receive $684 a month. At 70, you can purchase a second $100,000 annuity and receive another $775 a month, for a total income payout of $1,459 monthly. At age 75, you purchase a third $100,000 annuity to receive an additional $909 a month, increasing your combined annuity income to $2,368 per month. (These numbers are based on today’s payout rates, from immediateannuities.com)
The Benefits of Annuity Laddering
Obviously, if you ladder the annuities by delaying the purchase for 5 and 10 years in my example, you are foregoing the additional income in the early years. The trade-off is that you can invest that other $200k in the market. Using this strategy, you may come out ahead overall in the size of your retirement nest egg.
A study by MassMutual Financial Group produced some very interesting retirement income results:
The study, which tested four strategies for managing a retirement income account over 181 time periods (referred to as cases) between 1965 and 2006, found that the three strategies involving an income annuity, whether purchased all at once or over time, generally out-performed the stock and bond-only strategy, regardless of market conditions in the periods studied.
In fact, the investment-only approach, — even during strong equity and bond markets — ran out of money in 25 percent of cases. In contrast, the strategy of laddering into a life annuity matched the income goal in 100 percent of the cases tested.
This study also compared growth of the four different investment strategies using market data from 1980 to 2006. The stock and bond portfolio ended with a value of $489,346. The portfolio using laddered annuities ended at $735,292. This was the highest value of all the strategies that were tested.
Obviously, market conditions can change but that is one of the potential advantages of a ladder of annuities. You might get a much better return on one of the annuities you buy later in the ladder.
A related benefit of an annuity ladder is that by purchasing the annuities from different companies, you reduce the risks associated with an annuity company going bankrupt.
Final Thoughts on Annuity Ladders
Annuity ladders are not for retirees who need all of the income immediately. If you are one of those, many experts think that a laddering strategy that ends half-way between your present age and your life expectancy is the sensible approach.
If you are patient and good with numbers, you can run an analysis yourself, comparing the return on a single annuity with the combined return of multiple laddered annuities with the delayed premium money invested in the market.
Photo credit: Kevin Steele
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