Introduction
An annuity is a contract between you and an insurance company. In exchange for a lump sum or a series of payments, the company promises to provide you with a steady stream of income either immediately or at some point in the future. An annuity ladder is when someone purchases multiple annuities over a set period. For example, a person may have $100,000 available to purchase an annuity. To minimize the risk of locking in an interest rate today that may be significantly higher in future years, this person could purchase an annuity for $25,000 each year for four years.
What is an annuity ladder?
An annuity ladder, simply put, means buying multiple annuities over a set period. But an annuity ladder can have a few different looks.
Spread Out Your Purchases
Similar to dollar cost averaging while investing, spreading out annuity purchases over time may provide some interest rate risk management. An example would be having $300,000 to purchase annuities and spending $100,000 per year. However, this would certainly be a qualified recommendation. Annuity interest rates tend to track the bonds market. Looking at Federal Reserve data of Moody’s AAA Corporate bond yields from 2000 to 2024, rates have steadily dropped from 7.62% in 2000 to 2.48% during the pandemic in 2020, only to recently rise to 5.07% so far in 2024. Historically low interest rates over the last 20+ years would have made a dollar cost averaging type strategy a net loss over most years.
Multiple Payout Dates
While spreading out your principle may not ultimately mitigate the risk of interest rate variability, it may still be a part of a larger retirement income plan. Staggered payout dates might be a possible solution to longevity risk. By maintaining a foundation of guaranteed income throughout the later years of your life, the risk of outliving your assets may be decreased.
Purchasing Several Types of Annuities
If you would like to combine the guarantee of a fixed income annuity but also get the potential upside of an index annuity, you may be able to include that in your laddering strategy as well. This way, you can mitigate the effects of inflation and hedge against a poor interest rate environment (for example, the 2000-2020 years). When buying different annuities, this would also be the time to consider purchasing annuities from other companies to keep diversified and “not have all your eggs in one basket.”
Potential Drawbacks
As discussed previously, laddering annuities to hedge against lower interest rates in the future has its set of risks. For each annuity you purchase there will also be new fees and costs associated with it. Having multiple annuities, especially different types, will also add to the complexity of your portfolio not to mention multiple insurance companies to deal with.
Conclusion
So, the next question would, is an annuity ladder right for you? That answer to that is – it depends. If done well, it can be a very beneficial piece of an overall retirement income plan. A trusted and experienced advisor is a key piece of this puzzle. So the next steps will include researching the different types of annuities available and gaining expert help for a safe and comfortable retirement.