These days, the notion of running out of retirement income before your time runs out is a real threat. According to financial planners, a 4% rate of withdrawal on retirement assets is most likely to ensure that your income will outlast you. It sounds simple, but this also means that in order to collect $40,000 per year, you'll need to have $1 million in the bank. Laddering annuities is an approach that alleviates the worries of relying on Social Security, pension plans and running out of money during retirement because this investment strategy can create income that's guaranteed for life.
According to the Uran Institute, an economic and social research organization, retirement accounts lost 32% of their value between September 2007 and December 2008 - the heart of the economic crisis in the U.S., but while economic downturns can impede retirement goals, research has found laddering annuities can be an effective strategy in many market conditions.
What Is It?
An annuity is a contract between you and an insurance company. An individual provides money to the business and the cash accumulates through capital gains. Taxes are deferred. The tax is paid when you start making withdrawals, but that's after the age of 59.5. In certain situations, an IRS tax penalty is imposed to discourage people from taking money out of an annuity product, such as a deferred annuity, too soon.
In addition, the insurance company that you set up your annuity with is likely to apply surrender charges to recoup costs of the annuity they sold. This is particularly likely if the amount taken exceeds a stipulated free withdrawal amount of 10% of the annuity that the insurer may have allowed. There's also inflation to worry about, but luckily there are inflation-protected annuities (IPA) too, which could be an essential part of a solid financial plan.
When it is time for you to receive payouts, you can either take the money out all at once or have the insurance company provide systematic payouts, such as each month, quarter or year. How the annuity payout is calculated is determined by interest rates and your age. Insurance companies tend to pay more with age because you are nearing your life expectancy. However, there are situations that can arise when an owner or annuitant dies.
How It's Done
An annuity ladder involves the purchase of annuities in phases and can involve multiple annuity products. For example, an individual at age 65 may want cash to help with bills. The individual may divide some of the money set aside for an investment in annuities to purchase an immediate fixed annuity product now. Meanwhile, their remaining assets in stocks and bonds continue to grow and build wealth. Five years later, the retiree can help supplement the income from the fixed immediate annuity with the purchase of another annuity from a different company using a portion of their savings. A couple of years after that, the retiree may purchase another annuity from a different company, and so on, and so on.
This strategy can create not only an income stream, but can also help maintain and build a substantial amount of money in other securities. Purchasing annuity products from different companies helps to reduce damage to an investment portfolio if a company happens to encounter financial difficulties or closes shop.
Another strategy is purchasing all the annuity products at once. In this case, the individual may have a fixed immediate annuity that will start payments right away and in the meantime have deferred annuities that accumulate interest. As the income stream ends for the fixed immediate annuity, one of the deferred annuities would begin making payouts. The other annuities would begin payouts at future dates. Strategize an effective ladder with the help of a financial advisor. Fixed deferred annuities provide a way for investors to build their own pensions.
The Benefits of Annuity Laddering
Laddering "produces more guaranteed lifetime income, develops more liquidity to address other retirement needs and builds more long-term wealth than other commonly adopted retirement income strategies," according to a report by Mass Mutual. Four methods of managing a retirement income account over 181 time periods between 1965 and 2006 were tested, according to the report. The report discovered that all three strategies involving an income annuity outperformed the strategy of having stock and bonds only, regardless of market conditions.
"In fact, the investment-only approach, - even during strong equity and bond markets - ran out of money in 25% of cases. In contrast, the strategy of laddering into a life annuity matched the income goal in 100% of the cases tested," it said. Another added benefit is that certain annuities will allow your beneficiary to collect the payments at a minimum amount if you die during the payout period so, if you have a family there are annuities that will be perfectly right for you.
Keep This in Mind
Laddering annuities has some perks, but it is important to consider some factors, such as how monthly payments on an annuity of the same size can vary with different companies. Also, don't put all your eggs in one basket by just having annuities; allocate the investments to reduce risk, but also make sure that the investment portfolio is diverse. Consistently check and reevaluate your performance, and rebalance your portfolio if necessary.
The Bottom Line
Laddering annuities has been a little-known investment strategy, but it has shown to be a very effective tool that withstands fluctuating market conditions. The technique provides a comfortable income stream throughout your retirement. Also, if you're in need of immediate funds, there are annuities for that as well.