Annuity Laddering Strategies

You can use laddering strategies with annuities.
You can use laddering strategies with annuities. Image By Jorge Pereira / Getty Images

Annuities can be laddered for income or yield.

Most investors are familiar with the method of laddering CDs and bonds in order to stagger maturities. In this way, you can have money coming due free from surrender charges on an annual basis. The primary reason that laddering strategies are used is typical because  of interest rates, and the possible advantage of the potential increases. No one, not even the so-called “experts”, can correctly predict interest rate movements, so using laddering strategies is a prudent and effective way to address the interest rate unknown.

A fact unknown by most is that annuities can be laddered as well, and those laddering strategies can be for income or yield. Laddering CDs and bonds would be categorized as laddering for yield. With annuities, you can ladder for yield using fixed annuities, but you can also ladder for income as well.

MYGA annuity ladders produce yield similar to CDs.

Fixed Rate Annuities (aka MYGAs – Multi Yield Guarantee Annuities) work similarly to CDs. A fixed rate is a guaranteed rate lasting for a specific period of time. There are no annual fees with fixed rate annuities, and surrender charges decline annually over the contractual time period. The main difference between a CD and a fixed rate annuity (MYGA) is that the annual interest grows and compounds tax-deferred on an MYGA, when used in a non-IRA account (i.e. non-qualified). You have to pay taxes on the interest every year on CDs in a non-IRA account.

A common Fixed Rate Annuity ladder would be a 3, 4, and 5-year strategy.

For example, if you had $300,000, you would place $100,000 in the 3 year, 4 year, and 5 year fixed rate annuities. These types of fixed annuities have no fees, and the yield is guaranteed. As money comes due past its surrender charge period, you can take the money in full and pay taxes on the interest, or you can transfer it to another annuity and continue to defer the taxes.

I have created what I call a “Mixed Fixed Ladder”.

It is a combination of Fixed Rate Annuities (MYGAs) and Fixed Indexed Annuities (FIAs), and has the possibility of a slightly higher overall return because of the index option potential of the FIA portion of the ladder.

What is a Fixed Index Annuity, or FIA?

It is also referred to as an indexed annuity. This annuity type fully protects your principal, but also has a growth component attached to a call option on an index (typically the S&P 500). Indexed annuities were introduced in 1995, and designed to compete with CD returns. 

Laddering annuities for income is somewhat of a new concept to most investors. 

Annuities were originally put on the planet (as early as the Roman Times) to provide a guaranteed income. Laddering annuities for income can be structured many ways. Let’s take a look at a couple of annuity ladders that provide ongoing income:

The annuity Lifetime Ladder utilizes SPIAs.

The Lifetime Ladder involves buying Single Premium Immediate Annuities (SPIAs) over a specific period of time. The strategy is designed to catch interest rates as they rise (hopefully), in conjunction with the life expectancy of the annuitant (payee) decreasing with time.

Here’s a common example:  A person with $500,000 wants to guarantee a lifetime income stream, but is concerned that interest rates are low and that they might rise in the future. An efficient Lifetime Ladder would include the purchase of a $100,000 Single Premium Immediate Annuity (SPIA) every year for 5 years. Even if rates remain the same during that time period, the subsequent payouts will be higher based on the annuitant's age at the time of purchase.  If rates rise the payout will be even higher. 

The Target Date Stairstep Ladder utilizes DIAs.

This type of ladder involves Longevity Annuities (aka Deferred Income Annuities – DIAs), and starting the income at different intervals. The Target Date Stairstep Ladder strategy is typically used to combat future inflation by having different lifetime income streams turning on at future specific dates.

An example of this could be a 60-year-old with $400,000 allocated to cover for future inflation. Four separate Longevity Annuities (DIAs) would be purchased. One to start at age 65, 70, 75, and 80. Annuity income is primarily based on your life expectancy at the time the income stream is turned on, so as you age the payments are calculated higher. Each subsequent DIA would pay out at a higher rate

Step aside CDs and bonds, annuities are now king of the ladder.

There are many other laddering strategies that I have developed and implement with my clients.  Annuity laddering makes sense, and is a predictable and solid strategy because of the contractual guarantees and the fact that you can solve for the exact amounts needed.