As life expectancies stretch, clients may worry that they will outlast their savings.

An annuity-laddering strategy could help provide lifelong cash flow, thus trimming this longevity risk and easing clients’ concerns.

Holding annuities can help clients achieve “peace of mind,” says David Buckwald, a CFP and a senior partner and co-founder of Atlas Advisory Group, a financial planning firm in Cranford, New Jersey, even when considering the peril posed by a possible bear market near the start of their retirement.

These potential pros do come with some cons. Annuities can be illiquid and relatively expensive.

Today’s yields are modest, as is the case with many vehicles now. Moreover, the products used to construct a ladder range from straightforward immediate annuities, also known as income or payout annuities, to complex arrangements that require extensive advisor research and detailed explanation to clients.

Annuity ladders come in various shapes and uses.

“For income ladders, clients can ladder the annuity purchase date or the income start date … or both,” says Stan Haithcock, an independent annuity agent in Ponte Vedra Beach, Florida, who is widely recognized as Stan the Annuity Man. “For principal protection, I ladder contractual guarantees.”

Haithcock’s current principal protection ladder includes multi-year-guaranteed annuities with three-, four- and five-year guarantees. The guarantees here are promises from the insurers, so clients are relying on the continued financial strength of those companies.

“Rates depend on the state of residence and the rating of the carrier,” Haithcock says.

“The three-year is the shortest duration MYGA I’m willing to buy, and the five-year is the longest I am allowing my clients to lock in,” he says. “For three-year paper, the rate is around 2%, four-year paper pays 2.2% to 2.4%, and the rates for five-year paper are 2.65% to 3.1%.”

The MYGAs Haithcock that mentions promise the stated yield for the stated time period.

Penalties may apply for withdrawals before the expiration of the guarantee. When the guarantee expires, a MYGA can be renewed or moved to another issuer, with a more appealing rate.

MYGAs are similar to bank certificates of deposit, except that income tax can be deferred until money is withdrawn. Withdrawals before age 59 1/2 may trigger a 10% penalty, in addition to ordinary income tax.

Advisors who compare MYGAs to CDs may need to ensure that clients understand that annuities don’t have the same federal guarantees that many bank accounts enjoy.

Different types of products can occupy different rungs on annuity ladders.

“I use annuity ladders to create a guaranteed income stream starting at some point in the future, usually 10 years from the purchase,” says John Scheil, a CFP and the chief executive and owner of Cardinal Retirement Planning in Cary, North Carolina.

“The annuities cover the lifetime of either one individual or the individual and spouse,” he says. “ I show them the monthly income floor that is guaranteed by the insurance company to be paid for the rest of their life or lives.”

For these rungs on the ladder, Scheil uses deferred fixed-indexed annuities with a guaranteed lifetime withdrawal benefit.

FIAs also are CD cousins, with returns not fixed but pegged to one or more market indexes. FIA returns typically are limited on the downside by insurer guarantees and capped on the upside.

Previously, Schiel’s ladders also used fixed-period annuities that paid the income amount immediately, for 10 years.

“With interest rates so low, these fixed-period annuities are hardly worth buying,” Schiel says.

“In many cases, I have replaced the second annuity with a managed account invested in a five-year bond ladder of [ETFs],” he says. “Here, the client withdraws monthly income from principal and interest for the first 10 years.”

Haithcock also has a “mixed fixed” ladder, which is a combination of MYGAs and FIAs.

“I use FIAs with no attached riders,” he says. “FIAs historically have provided an enhanced CD return.”

Haithcock’s mixed fixed ladder combines three- and five-year MYGAs with six- and seven-year FIAs. For FIAs, the years on the ladder represent the surrender charge period.

The key to the mixed fixed ladder is that there are no annual fees, because no riders are attached, Haithcock says.

For income-oriented ladders, he uses single-premium immediate annuities, deferred-income annuities and qualified longevity annuity contracts. With SPIAs, cash flow commences with the upfront investment.

DIAs delay the cash flow, in order to boost the yield. Finally, QLACs are a form of DIA, for use in individual retirement accounts, that typically start late in life and reduce required distributions.

Annuity ladders may have a place in some clients’ portfolios, but there is some advisor concern about the product. The idea of laddering annuities inspires discouraging words from some industry experts.

“We have discussed laddering annuities, but we have not yet implemented this approach for any clients,” says Tom Orecchio, a principal and wealth manager at Modera Wealth Management in Westwood, New Jersey. “Conceptually, we think the strategy has merit, but we do have concerns.”

The greatest concern, according to Orecchio, is the lack of access to principal.

Although we understand that an annuities ladder can be similar to an indexed pension, once clients see an account balance, it is difficult for them to overcome their reluctance to give up access to that principal,” he says. “With most pensions, people never had access to the principal to begin with.”

Another worry is regarding the loss of principal or lifetime income in the event of a premature death.

“There are ways to overcome this drawback, such as using a joint and survivor payout, but this is another hurdle for investors,” Orecchio says. “Some annuities now offer riders to address this issue, but such riders can be expensive.”

Such objections are common to annuities, but what about the idea that lifelong annuity payments can modify longevity risk?

“Fortunately, for most of my clients, longevity risk and running out of money is not a primary issue,” Orecchio says.

Buckwald also is not using annuity ladders, though he has put clients into them in past years.

“We’re going to a bucket strategy instead, with money feeding from long-term to immediate-term to short-term buckets. Annuities can fit into this method,” Buckwald says.

“Research shows that people who have traditional pensions tend to live longer and live happier in retirement, with less stress,” he says. “Fewer people have pensions these days, but annuities can provide that kind of cash flow when they make up a portion of a client’s portfolio.”

This story is part of a 30-30 series on navigating the growing world of choices for clients. It was originally published on Oct. 11.

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