Updated Thursday, July 24, 2014 as of 1:48 PM ET
How to Build Annuity Ladders
Monday, May 26, 2014
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“In the past four or five years, there has been a tremendous increase in demand for guaranteed lifetime income,” says Bill Van Winkle of Van Winkle Associates, a financial planning firm in Tinton Falls, N.J. “With the specter of greater longevity, people are more concerned about outliving their income.”

The desire for guaranteed cash flow is evident in reports of higher sales of income annuities, which can provide a lifelong cash flow. According to Beacon Research, income annuity sales topped $11 billion last year, an increase of nearly 20% from 2012. Unfortunately, clients who buy an income annuity now are effectively locking in today’s low interest rates, which play a role in setting annuity payouts.

“With today’s historic low interest rates, it might be advantageous to plan to capture possibly higher rates in the future,” says Van Winkle, who is a career agent of New York Life. Just as bond ladders offer a method of periodically reinvesting at potentially higher yields, annuity ladders may provide both lifetime income and plumper payouts.

DEFERRED PURCHASE SCHEDULE

One laddering technique is to spread the money allocated to income annuities over a deferred purchase schedule. Regardless of what happens with interest rates, waiting to commit some funds means that clients’ life expectancies will be shorter when payouts start and that the annuity payouts are accordingly higher.

Today, for example, a couple who are age 67 and 65 might get $5,500 to $6,000 a year from a $100,000 investment in a joint annuity that will last as long as either spouse lives. Alternatively, they could invest $25,000 now and another $25,000 every five years until ages 82 and 80. An online annuity calculator indicates this couple might receive over $7,000 a year once that $100,000 is fully annuitized and the couple are in their 80s. This greater lifetime cash flow assumes today’s interest rates; if yields head north over the next 15 years, the total from the four income annuities on the ladder could be even higher.

DEFERRED INCOME ANNUITIES

These numbers are based on four immediate annuities, purchased at five-year intervals. An alternative approach would be to use deferred income annuities for the ladder. This couple could start with a $100,000 commitment now, stipulating that $25,000 be annuitized right away with the rest to start at five-year intervals, $25,000 at a time. Beacon Research reports that DIAs now represent 20% of all income annuity sales, up from 16% a year ago.

By letting the insurance company have the money during the deferral period, a DIA can produce a much higher eventual payout. Investing in a five-year DIA now, for example, could increase the lifetime payout by more than 15%, versus waiting until 2019 to buy an immediate income annuity. Of course, setting up this type of deferred payout means the client won’t have use of the money while waiting for payouts to begin.

OTHER APPROACHES

Insurance companies have initiated other approaches that may produce higher yields from income annuities. “We have seen a great deal of interest in annuities with an ‘income enhancement option,’ ” Van Winkle says.

Here, a couple buying a joint life immediate annuity might reduce their initial payouts by nearly 2% a year, to get this option. If a benchmark interest rate index is at least two percentage points higher on the policy’s fifth anniversary than it was at the time of purchase, the lifetime payout could increase by almost 25%.

Such innovations may help advisors find products to ease clients’ concerns about running short of money as they grow older.

Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.

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