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Ladder Annuities for Yield or Income

Many experts recommend laddering annuity purchases in the same way that people ladder CD and bond purchases.  This allows you to stagger the maturity dates and take advantage of potential interest rate increases.  It’s unknown what will happen with interest rates in the near or far future, so laddering can be an effective strategy to account for potential and likely changes.  Stan “The Annuity Man” Haithcock wrote about “Annuity Laddering” for about.com’s Money section.  When you ladder CDs and bonds, you use the strategy of laddering for yield.  Annuities, however, can be laddered for either yield or income.

Fixed annuities are used to ladder annuities for yield.  A Multi-Yield Guaranteed Annuity (MYGA) works like a CD except when it comes to taxes.  When you have a non-qualified fixed annuity, your interest grows and compounds yearly tax-deferred.  With CDs in a non-IRA account, you pay taxes yearly on your interest.  There is no annual fee and your surrender charges go down each year of the contract with fixed rate annuities.  Haithcock says that a common annuity ladder would be a 3, 4 and 5 year strategy.  With $300,000 to spend on a fixed annuity, you would put $100,000 each in a 3 year, 4 year and a 5 year contract.  Your interest is guaranteed and there are no additional fees with this type of annuity.  You have two choices when the time frame of the contract is up.  If you choose to take the money in full, you have to pay taxes on the interest.  Taxes will continue to be deferred if you transfer your money into another annuity product.

You can also ladder annuity purchases using a fixed indexed annuity, a newer product introduced 20 years ago.  With an indexed annuity, your principal is protected and your interest is attached to a stock market index like the S&P 500.  This type of annuity was introduced as a competitor for CD returns because you have the potential for a higher rate of return.  Haithcock created a “Mixed Fixed Ladder” that combines fixed annuity products and fixed indexed annuity products to give you a potentially higher overall return than with fixed annuities alone.

The second way that you can use an annuity ladder is for creating income.  It’s a newer concept that can be used in a couple different ways.  If you are looking to create lifetime income, you would use single premium immediate annuities (SPIAs).  Your hope is that annuity rates will increase over time at the same time that your life expectancy is decreasing as you age.  If you have $500,000 to purchase an immediate annuity, you could purchase a $100,000 immediate annuity every year for five years.  Many people choose this type of strategy when they are worried that interest rates are low.  If rates go up during this time, you take advantage of those interest rate increases.  Even if interest rates don’t increase during this time, your life expectancy has gone down over those five years so your payout will be higher.

In addition to creating income with an immediate annuity ladder, you can also ladder longevity annuities to create lifetime income.  This Target Date Stairstep Ladder starts your income at different dates in the future.  This strategy uses longevity annuities, also known as deferred income annuities, to help combat inflation risk.  A 60 year old with $400,000 to spend to cover inflation increases could buy a $100,000 longevity annuity to start at each of four ages: 65, 70, 75 and 80.  The income you receive from your annuity is based on your life expectancy, so every five years that goes by you will actually receive higher payouts even if interest rates remain the same.

The more you learn about annuity laddering, the more that it makes sense for many people’s financial plans.  Speak with an annuity expert at Annuity FYI to help answer questions about laddering immediate annuities or longevity annuities.  This could be an effective way to ensure positive yield or create income during your retirement.

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