How to use annuity ladders to transfer risk

With interest rates at these current low levels, laddering strategies have become popular once again as a way to hedge your bet against future interest rate movements. Most investors are familiar with laddering bonds and CDs, but there are a few annuity laddering strategies that you should be aware of as well.

MYGA fixed-rate ladder

Fixed-rate annuities are commonly referred to as a Multi-Year Guarantee Annuity, or MYGA. These products work similarly to a CD because a contractually guaranteed annual rate is locked in for a specific period. The main difference is that with a MYGA, you don’t pay taxes on the interest until the money is withdrawn in a non-IRA account, so the annual yield can grow and compound tax deferred. With CDs in a non-IRA account, taxes are paid on the interest earned on an annual basis.

The shortest duration MYGA is currently three years, and I’m now recommending these fixed-rate ladders with three-, four- and five-year surrender periods. If implemented outside of an IRA, the annual yields will grow and compound tax deferred until you take the money out. At the end of the surrender period, the money is fully available to you, or you can transfer it to another annuity and hopefully at a higher rate. That annuity to annuity transfer would be a nontaxable event under the direct transfer 1035 exchange rule. In my opinion, the key to the MYGA fixed-rate ladder is to keep the durations five years and in so you have money coming due as interest rates hopefully rise in the near future.

Mixed fixed sandwich ladder

This is a strategy that I developed over the past few years while the 10-year Treasury has unfortunately remained at or below 3 %. Everyone is searching for yield, but most want to make sure that the principal is safe and fully protected as well. That’s a tough combo wish list in this Bernanke/Yellen world of low rates.

The mixed fixed sandwich ladder involves using both fixed-rate annuities (MYGAs) with fixed-index annuities and sandwiching them between each other. Index annuities were designed to compete with CD returns (not the market) and with most offerings, the gains are locked in annually from an option on an index like the Standard & Poor’s 500. Your principal is protected, and there is a possibility for gains a little higher than most fixed-rate instruments. Index annuities have no fees when you buy them without riders and short durations, and this is how they are set up within this specific ladder strategy.

An example of this mixed fixed ladder is to split the money between a three-year fixed-rate annuity, a four-year fixed-indexed annuity, a five-year fixed-rate annuity, and a six-year fixed-indexed annuity. The 2 MYGAs (3 and 5 year) have a contractually guaranteed annual yield, and the index annuities (4 and 6 year) are principal protected with limited upside on the S&P 500. Also, with any fixed indexed annual return, that amount is locked in never to go below that amount.

Lifetime ladder

A lot of people need to fill income gaps right now, or at a minimum, within the next couple of years. For that income now solution, a Single Premium Immediate Annuity, or SPIA, is the highest contractual payout available and the logical transfer of risk recommendation. The problem with that thought right now is putting all of your money into a SPIA at one time will permanently lock in these current low rates. So this ladder strategy involves buying a SPIA every year and over a specific time period.

The Lifetime Ladder strategy is guaranteed to increase your income because even if rates don’t move you are one year older which makes your life expectancy less, which will increase the payout. If rates do happen to move in your favor, then the income stream will be even higher. So if someone was looking to place $400,000 into a SPIA right now, I might recommend a Lifetime Ladder that would have you buy a $100,000 SPIA every year for four consecutive years.

Target-date stairstep ladder

If you’re trying to plan for guaranteed income in the future, you can contractually ladder those lifetime payment start dates. Remember that annuity lifetime income guarantees are based on your life expectancy at the time you start the payments. The later you start, the shorter your life expectancy, which in turn means a higher guaranteed income amount.

Longevity annuities and income riders attached to fixed-deferred annuities are the only two annuity strategies used in this target date ladder. An example of the Stairstep Ladder is to have contractually guaranteed income start in three, five, seven and 10 years. This is a great planning tool because you will know to the penny the exact lifetime income amount for each specific start date.

COLA inflation ladder

Cost of Living Adjustment, or COLA),riders are annual increases to an annuity income stream that can be contractually added to some policies. With the Target Date Stairstep Ladder and the Lifetime Ladder, you can add the COLA inflation component if desired. It’s important to point out that adding a COLA to an annuity policy lowers the initial payout, but if you have a history of longevity in your family it might make sense. I typically show all income annuity quotes with and without a COLA just so you can see the difference in payouts.

No one knows when rates will rise, or if they will remain stagnate and flat for years to come. Annuity laddering strategies might be able to help with the guaranteed part of your portfolio, and all of these strategies are customized to everyone’s specific situation. At a minimum, it’s good to be aware of as many ideas as possible to help you achieve your financial goals. In these strange economic times, the more financial ammunition, the better.

Originally published 2.11.14 by –