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  • Writer's pictureRetirement and Annuity Advisor Jennifer Lang

How an Annuity Laddering Strategy Works in Retirement Planning

When we are ready to retire we must convert the growth of our savings and investments into a source of regular and reliable income, an income that will last for 20 or 30 years of retirement.

Of course most financial advisors will advise us to withdraw only the interest dividends or profit on our investments so that we can never run out of money. But we know that interest rates, stock dividends and market valuations will vary considerably from year to year. Especially over 20 or 30 years of retirement and if our investment earnings cannot provide us with enough income, we will need to take withdrawals of both earnings and principle and manage those withdrawals very carefully as we spend down our savings over 20 or 30 years. But if we make any mis-calculations or if our investments do not perform as well as we expect them to, or if we should live longer than 20 or 30 years, we could very easily run out of money. So what's the alternative? Well, we can convert our retirement savings into three separate ten-year payout periods, each one with a certain guaranteed income and the third one with a guarantee to continue the payout for as long as we live. Even if we live into our hundreds. These payout periods are referred to as income buckets and they can replace the uncertainty of interest rates, stock dividends, bond yields and market valuations with the certainty of a regular and reliable guaranteed monthly income. It's like having our own personal pension plan. What's more, income buckets enable us to safely and confidently take as much as thirty percent more income during the first  20 years of our retirement because we know with certainty and assurance that we will have sufficient income guaranteed during the second 20 years of our retirement or for as long as we live. What's more we can do it all without any risk of taking out too much or too little and without any dependence on interest rates, bond yield, stock dividends or market valuations. So we never need to worry about the safety of our money or the need to carefully manage our investments.

For many households, the guaranteed income from Social Security (and a pension, if you’re lucky enough to have one) won’t cover 100% of basic living costs. A popular strategy to fund that essential-spending gap, has been to move a chunk of money into cash and/or bonds to cover those living expenses for a few years.

But cash and bonds aren’t the only option for your “safe money.” In fact, annuities can be preferable, says Dr. David Pfau, a chartered financial analyst (CFA)  and Professor of Retirement Income at The American College and holder of a doctorate of economics from Princeton University states: 

“A low-interest rate environment is risky for investors, especially those approaching retirement. First, it is important to understand that bond prices will decrease if interest rates rise. Bond funds can be volatile and experience losses, and individual bonds may also experience loss when sold before maturity. Bond duration is a measure of just how sensitive bond prices are to interest rate changes.”

In considering deferred fixed annuities and the benefits they might provide relative to other fixed choices, Pfau points out four advantages:

1. Protection of the annuity’s value from investment volatility.

Deferred fixed annuities support growth at a specific interest rate without exposure to price fluctuations and potential losses as interest rates change,” Pfau observes. “Principal is protected and secured. This provides a way to take risk off the table in the pivotal years before the retirement date.”

2. The ability to earn higher yields than Treasury bonds.

Insurance company general accounts may invest in higher-yielding corporate issues to provide diversification (similar to a bond fund), while protecting the annuity contract holder from interest rate risk. And they provide the principal protection similar to an individual bond held to maturity.

3. Reduction in credit risk.

Because insurance companies can diversify their holdings across a wide range of fixed-income securities, deferred fixed annuities may offer lower credit risk.

4. Tax deferral.

Assets grow faster when investors are able to defer taxes on the interest earned until they actually withdraw it, or it is distributed to them. Because an annuity is tax-deferred for individuals, deferred fixed annuities postpone the taxes on growth until the annuity’s maturity date, allowing interest to compound, untaxed.

Wait Until Closer to Retirement?

If you think you won’t face this risk anytime soon because you have several years until retirement, Pfau has a finding on that, too.

Laddering annuities could be a good strategy if your retirement isn't eminent, according to Pfau. This approach lets you put money into annuities over time instead of all at once. That can help you manage inflation risk, along with maximizing your guaranteed lifetime income.

Here's an example of how annuity laddering works. The first income bucket might begin at age 60 or 65 and pay out all of that money over the first ten years of our retirement before it would be replaced by the second income bucket. 

So the second income bucket would begin at age 70 or 75 and pay out a new monthly income guaranteed for another ten years to age 80 or 85 and this second ten year payout can be higher than the first ten year payout in order to offset the rate of inflation. Now the third income bucket would only begin the payout if you make it to age eighty or eighty-five and this third bucket would be guaranteed not just for another ten years but for as long as you live. Even if you live to be a hundred and twenty and if you don't make it to age eighty or eighty-five, your heirs will receive annual installments until all the money you put into that bucket is paid back out.

An annuity -- or any financial or insurance solution for that matter -- must make sense for you and your financial circumstances.

​The strategies and solutions that can help you reach your retirement goals must be customized to your unique situation. Contact us today!

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