Concern over outliving retirement savings is very legitimate as life expectancies continue to lengthen. One method of providing peace of mind over this worry is through annuity-laddering. Annuity products can help provide a lifelong cash flow, but because they often can be illiquid and relatively expensive, they aren’t for everyone. Here’s a more in-depth look at this financial strategy, from the financial experts at Financial Planning magazine.
Annuity ladders come in a variety of shapes and sizes.
“For income ladders, clients can ladder the annuity purchase date or the income start date…or both,” said Stan Haithcock, an independent annuity agent in Ponte Vedra Beach, Florida who is also known in the industry as Stan the Annuity Man. “For principal protection, I ladder contractual guarantees.
Haithcock’s current principal protection ladder includes multi-year-guaranteed annuities (MYGA) with three-, four-, and five-year guarantees.
“Rates depend on the state of residence and the rating of the carrier,” he added. “The three-year is the shortest duration MYGA I’m willing to buy, and the five-year is the longest I am allowing my clients to lock in. For three-year paper, the rate is around 2%, four-year paper pays 2.2% to 2.4% and the rates for five-year paper are 2.65% to 3.1%.
MYGAs are comparable to bank CDs with the exception that income tax can be deferred until money is withdrawn. However, if withdrawals begin before age 59 ½, a 10% penalty may be triggered. It is also important to point out when comparing MYGAs to CDs that annuities don’t have the same federal guarantees many bank accounts enjoy. When the guarantee on a MYGA expires, it can be renewed or moved to another issuer, often with a more appealing rate.
Different types of products can be uses on different rungs on annuity ladders.
“I use annuity ladders to create a guaranteed income stream starting at some point in the future, usually 10 years from the purchase,” said John Scheil, CFP, CEO and owner of Cardinal Retirement Planning in Cary, North Carolina. “The annuities cover the lifetime of either one individual or the individual and spouse. I show them the monthly income floor that is guaranteed by the insurance company to be paid for the rest of their life or lives.”
Scheil’s ladders have previously included deferred fixed-indexed annuities with a guaranteed lifetime withdrawal benefit, which have returns that are typically limited on the downside can capped on the upside. He’s also used fixed-period annuities that paid the income amount immediately for 10 years.
“With interest rates so low, these fixed-period annuities are hardly worth buying,” Scheil added. “In many cases, I have replaced the second annuity with a managed account invested in five-year bond ladder of ETFs. Here, the client withdraws monthly income from principal and interest for the first 10 years.”
Haithcock has also used a “mixed fixed” ladder, combining MYGAs and FIAs. “I use FIAs with no attached riders,” he said. “FIAs historically have provided an enhanced CD return.”
To create a ladder focused on income, Haithcock uses single-premium immediate annuities, deferred-income annuities and qualified longevity annuity contracts. With SPIAs, cash flow begins at the time of investment. DIAs delay the cash flow so that the yield is boosted, and QLACs are a form of DIA used in IRAs. They usually start late in life and reduce required distributions.
While annuity ladders definitely have a place in some investors’ portfolios, there are some concerns for others.
“We have discussed laddering annuities, but we have not yet implemented this approach for any clients,” said Tom Orecchio, principal and wealth manager at Modera Wealth Management in New Jersey. “Conceptually, we think the strategy has merit, but we do have concerns. Although we understand that an annuities ladder can be similar to an indexed pension, once clients see an account balance, it is difficult for them to overcome their reluctance to give up access to that principal. With most pensions, people never had access to the principal to begin with.”
Another concern is in regards to potential loss of principal or lifetime income in the event of a premature death. “There are ways to overcome this drawback, such as using a joint and survivor payout, but this is another hurdle for investors,” Orecchio added. “Some annuities now offer riders to address this issue, but such riders can be expensive.”
Written by Rachel Summit