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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I performed the following analysis for a 65 year old retiree covering ages 65 thru 80:
With the one-time $300,000 annuity purchased at 65, at age 80 the retiree would have received total $2,050 monthly payments of $369,000.
If he had instead purchased (i) a single $100,000 annuity at age 65, he would have received $684 monthly payments totaling $123,120 at age 80. By additionally purchasing (ii) a second $100,000 annuity at age 70, he would have also received $775 monthly payments totaling $93,000 at age 80. Finally, by adding (iii) a third $100,000 annuity, purchased at age 75, at age 80, he would additionally received $909 monthly payments totaling $54,540. These these three annuities would have provided him a total of $270,660.
Assume that the retiree was able to the invest the dollar difference between the three laddered annuities and one-time $300,00 annuity at a fixed interest rate of 3% (i.e., the interest earned on $100,000 for 10 years at 3% plus the interest earned for 5 years at 3% = $50,319). Adding this to the $270,660 paid to him by the three annuities brings his total annuity payments and 3% fixed interest earnings to $320,979, or $48,021 less than the cummulative monthly income earned from the single $300,000 annuity.
Based upon the monthly difference between the amounts which he would have received between the single $300,000 annuity ($2,050) and three laddered annuity payments ($2,368) at age 80 and beyond, our retiree would have to reach an age of nealy 93 years before the laddered annuities payments surpassed the single annuity total.
Note that this analysis does not even address the fact that the retiree would have to have significant savings reserves available in order to offset the decreased annuity payments received during the initial years of his retirement.