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Annuity laddering is a financial strategy of purchasing several annuities of lower value over a period of years. When interest rates are low, laddering can offset the small returns from annuities by allowing the owner to stagger the end dates of the contracts.
One of the challenges of purchasing an annuity or investing stocks or real estate is entering the market at the best time to maximize return.
A strategy known as laddering — or buying multiple financial products with different maturity dates — is one way to address this challenge.
What Is Laddering?
Financial expert and Forbes contributor Matt Carey said in a 2018 Forbes article, “Laddering spreads out maturities of different fixed income instruments so that you are consistently able to access some funds for liquidity, while simultaneously taking advantage of higher rates on longer-term instruments.”
It’s a strategy meant to increase the chance of earning more money when interest rates swing upward.
You might, for example, open a new CD, invest in a different bond or buy an annuity every year for several years to get the best deal available under the economic conditions of the time period during which you make each transaction.
Those conditions include changing interest rates, which the insurance companies determine using factors that include your age and life expectancy.
Your age at the time of an annuity purchase and, more importantly, your age when payouts begin will affect the offer you get for an annuity.
Why Investors Ladder Annuities
Laddering annuities is meant to offset sluggish returns. There is a significant opportunity cost to investing in a long-term product when the market is performing poorly. This strategy serves to mitigate this loss.
Laddering is attractive to investors for other reasons, too.
“The main benefits of laddering are spreading interest rate and reinvestment risk over time, and getting short-term liquidity while taking advantage of longer term rates,” Carey told Forbes.
This can be especially consequential when you’re talking about setting up your retirement funds, which should not be so rigid that your income can’t keep up with the increases in your cost of living.
In other words, you don’t want to tie up all your money in low-rate vehicles and forgo the opportunity to move it into investments that would perform better.
At the same time, you don’t want to invest in hopes interest rates will go up only to see the rates sink even lower.
Different Ways to Ladder
A financial advisor can help you determine the best laddering strategy for your situation. Your advisor may suggest one of the following tactics.
Spreading Out Your Principal
Maybe you have a total of $400,000 to invest in annuities. You can use $100,000 each year toward an annuity purchase.
This also allows you to invest part of your retirement savings to see if you’re comfortable with annuities before tying up a large percentage of your savings.
Another way to ladder annuities is to buy several fixed-rate annuities with different surrender periods. The surrender period is the amount of time you must wait to withdraw funds from your annuity without facing a penalty. If you do need to withdraw more than what is allowed in the contract, you will have to pay a surrender charge.
At the end of the surrender periods, you can withdraw your money without penalty as long as you’re at least 59.5 years old. Alternatively, you can move the funds to an annuity with better terms through a 1035 exchange. These exchanges are a way to trade in one annuity for another without tax consequences. The 1035 refers to the provision in the tax code that covers them.
If the annuity contract is as good as the offerings at the end of the surrender period, you can keep the annuity contract as is. Having several annuities with different surrender periods allows you to review the terms of each contract at the end of its surrender period and decide whether you could get better returns in another annuity.
Take Advantage of Different Features
You can also ladder various types of annuities. For example, you can invest some of your money into the purchase of fixed annuities while investing other funds into indexed or variable annuities. This allows you to have a balance of the advantages and disadvantages of each type.
Because each type of annuity has unique benefits and drawbacks — such as the reliability of predetermined interest rates on fixed annuities versus the less stable rates of variable annuities, which are tied to the performance of their subaccounts and may ultimately provide higher returns — if you ladder different types of annuities, you create more opportunity to benefit from, or protect your money from, market volatility.
Increase Your Payments by Staggering Payout Dates
Finally, in addition to laddering the actual purchase of annuities, you can ladder when they will start paying you income, beginning at the age of 59 ½.
The older you are when you start receiving the payments, the higher the payments will be. This is because life expectancy is one of the factors that determine annuity payout amounts. The longer your life expectancy, the lower your payments will be.
In addition to allowing you to take advantage of different market conditions, diversifying annuities from different companies gives you a layer of protection against the unlikely chance that one of the insurance companies goes bankrupt or runs into financial problems.
10 Cited Research Articles
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- Bulmer, S. and Hedstrom, K. (2012, June 21). Customize Annuity Options With Laddering. Retrieved from https://www.thinkadvisor.com/2012/06/21/customize-annuity-options-with-laddering/
- Carey, M. (2018, September 4). 2018 Guide to Bond, CD And Annuity Laddering. Retrieved from https://www.forbes.com/sites/mattcarey/2018/09/04/2018-guide-to-bond-cd-and-annuity-laddering/#21475ffc2d00
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- Insured Retirement Institute. (n.d.). Taxation of Annuities. Retrieved from https://www.irionline.org/government-affairs/annuities-regulation-industry-information/taxation-of-annuities
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- Marquit, M. (2019, October 16) Should You Invest in Annuities? Interview with Stan the Annuity Man. Retrieved from https://investorjunkie.com/alternative-investments/interview-stan-annuity-man/
- Myers, R. (n.d.). Building a Ladder to Financial Security. Retrieved from https://www.wsj.com/ad/article/annuities-buildingladder
- Roth, A. (2019, January 14). An Annuity Hater Revisits SPIAs. Retrieved from https://www.advisorperspectives.com/articles/2019/01/14/an-annuity-hater-revisits-spias
- Sheedy, R. (2012, April 19). Hedge Bets With an Annuity Ladder. Retrieved from https://www.kiplinger.com/article/retirement/t003-c000-s001-hedge-bets-with-an-annuity-ladder.html