A Ladder of Annuities Can Hedge Your Bets

EDITOR'S NOTE: This article was originally published in the August 2008 issue of Kiplinger's Retirement Report. To subscribe, click here.In today's low interest-rate environment, locking up a big chunk of your portfolio in a fixed immediate annuity may not seem wise. But if you like the security of guaranteed payments and you believe rates will rise in coming years, you can hedge your bets by laddering annuities.

As with ladders of bonds or certificates of deposit, the strategy calls for buying fixed immediate annuities over a period of time. Instead of spending a lot of money on a single annuity that locks you into one rate for your lifetime, you split your money among several. Perhaps you buy an annuity every year for five years, or every five years over the next 15 years.

Today's payouts for fixed immediate annuities are relatively low because interest rates and bond yields are low. A 70-year-old male could get an average monthly payout of $7.21 per $1,000 invested, compared with $8.32 in the summer of 2000.

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Financial analysts disagree over whether rates are headed up or down. But Drew Denning, vice-president of Income Solutions for The Principal, a financial-services firm, says, "If you can't get the experts to agree, you kind of bet on both sides with laddering."

In addition to possibly benefiting from higher interest rates, laddering enables you to capture higher payments because of your age. The older you are when you buy a fixed immediate annuity, the higher the payout you'll receive. Say a 65-year-old man in Virginia wants to spend a total of $300,000 on annuities. If he buys a $300,000 lifetime annuity with no payments to beneficiaries at 65, he'd receive $2,025 a month, according to a recent quote on ImmediateAnnuities.com.

Instead, if he wants some guaranteed income at age 65, he can buy a lifetime annuity for $100,000 now and get $675 a month. At 70, he buys another $100,000 annuity to get an extra $769 a month, for a total payout of $1,444. He buys his third $100,000 annuity at 75 to get $907 a month, boosting his combined payout to $2,351 a month. This assumes interest rates and life expectancies remain the same.

You will forgo the extra guaranteed income early on. But the money that's not annuitized could continue to be invested in the markets.

Faster Investment Growth

There's no guarantee that an annuity ladder would provide more income than if you'd bought one annuity. But research indicates that laddering annuities might boost a nest egg.

A study by MassMutual Financial Group compared several retirement-income strategies, including one portfolio made up just of stocks and bonds and one that also included a ladder of fixed immediate annuities purchased at various times. Each portfolio started off at $100,000 and was assumed to be held by a 65-year-old man.

The study reviewed the investments' growth using market data from 1980 to 2006. The stock and bond portfolio ended up with a value of $489,346, while the one with laddered annuities ended at $735,292, the highest value of all the strategies tested.

As for deciding how to stagger your ladder, there are no hard and fast rules. Jerry Golden, president of MassMutual's Income Management Strategies division, says, "Generally speaking, you want to get to halfway between your age and your life expectancy." He says, for example, a 65-year-old would want to complete the ladder in about ten years.

Also, consider buying products from several companies to spread your risk if one of the insurers goes under. States generally offer up to $100,000 in liability protection, although rules vary by state.

If you need more guaranteed income right away, laddering might not be suitable. "Waiting has a cost," says Hersh Stern, who runs ImmediateAnnuities.com. "The cost is the loss of the monthly checks." He also cautions that rates could still decline.

But Denning notes that laddering provides a psychological benefit. Someone who is 65 might feel comfortable monitoring a portfolio closely, but by 75 wants to have the security of a guaranteed income stream.

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