“A desire to preserve cash savings and turn that money into lifetime income is a primary reason some people decide to purchase annuity products. “Laddering” can help these products work even more efficiently.”- Jerry Yu
It’s genuinely shocking when I run across people already in retirement or just a few years away from retirement who have 70% or more of their money on Wall Street. Substantial investment in equities may be an excellent move for someone in the accumulation phase of their financial life. However, for seniors, this strategy doesn’t usually have a happy ending. Chasing returns is understandable, though, especially in the past few years’ brutal interest-rate environments. Fortunately, there is a widely-accepted and proven strategy that can help you take advantage of interest rates that might increase in the next few years.
What is an annuity ladder, and how does it work?
Depending on the phase of a person’s financial life, an annuity ladder can be used either for wealth creation or as a method of preserving one’s wealth. Laddering involves purchasing immediate annuities over a period to create guaranteed income while at the same time minimizing interest-rate risk. It doesn’t make sense to lock in rates for long periods when interest rates are low. Even economists cannot predict with any degree of accuracy where interest rates will wind up. Building an annuity ladder allows you to buffer against the risk of low returns.
Annuity ladders can also assist in creating tax free-income through the use of a Roth IRA conversion strategy. Also, because annuity ladders use products from various insurance companies, they can be useful tools for mitigating losses should a particular carrier fail. Annuity ladders are constructed around either income or principal protection models.
For example, a principal protection ladder may include a selection of multi-year-guaranteed (MYGA) annuities with 3, 4, or 5-year guarantees. In this case, the guarantees rely on the continuing financial strength of the issuing companies. Rates for these types of annuities depend on carrier ratings and the state in which the annuitant resides.
Annuity ladders can also create guaranteed income streams that start at a certain point in the future. These annuities cover either the lifetime of one person or the lifetime of that person and their spouse. This type of ladder provides a monthly income “floor” that is guaranteed for life. A common way of constructing an income ladder is by using fixed-indexed annuities (FIAs) that have guaranteed lifetime withdrawal benefits.
Are there downsides to laddering annuities?
Like every financial tool, annuity laddering has some downsides worth considering.
Some of the more essential cons of annuity ladders include:
Loss of liquidity. Access to cash in an annuity ladder is very restricted and governed by the contracts you signed.
There are penalties for early withdrawal. As is the case with other types of retirement planning vehicles, penalties and income tax may come into play if you need to withdraw your money before age 59 ½.
The FDIC does not protect them. Annuity issuers are among the most conservative and regulated companies in the United States. Still, unlike CDs, there is no FDIC protection for annuity products. The safety of an annuity rests primarily on the claims-paying ability of the issuing company.
Variable annuities on a ladder can increase market risk.
Some advisors use variable annuities on a ladder. I caution against this in most cases as variable annuities do carry a fair amount of market risk and the potential to lose your principal.
The bottom line
Laddering annuities are an effective way for some individuals to create wealth or protect what they have already accumulated. Laddering may be a useful buffer against being locked into low-interest rates for long periods and can help safeguard against losses in the event of insurer insolvency.
An annuity ladder is a sophisticated financial design that needs to be undertaken with a high degree of diligence. If you are looking into laddering, it’s wise to seek help from a trusted advisor who has experience putting together successful annuity ladders.