When your financial advisor starts to talk to you about laddering, realize that they are talking to you about using financial products with varying maturities and that they are most likely not thinking about a trip to the hardware store.
In today’s low interest rate environment laddering annuities allows clients to potentially capitalize on increasing rates without forgoing returns that can only be obtained by committing to a longer maturity period. Laddering provides an opportunity for conversion of shorter maturity annuities to better options if they are available earlier – then the maturities continue to provide that option on a regular ongoing basis.
Perhaps the best option to ladder annuities is by staggering deferred hybrid annuities for future income. By laddering hybrid annuities you can create a income stream that will combat inflation and provide for added flexibility with future income. It can also be an excellent strategy for financial security should you live a longer then expected life.
Eric and Dick break down some of the pros and cons for laddering annuities.
Guarantees, including optional benefits, are backed by the claims-paying ability of the issuer, and may contain limitations, including surrender charges, which may affect policy values. During this segment, Dick and Eric are referring to Fixed Annuities unless otherwise specified.
See how Scott Bulmer and Kevin Hedstrom address this same topic in a recent issue of Life Health Pro.
Customize Annuity Options With Laddering
As an agent who has worked with hundreds of clients to help them build and protect their retirement nest eggs, I am now faced with helping my clients make the dramatic shift from the wealth management phase (gathering and growing assets) to the income management phase (preserving and distributing assets). With 78 million baby boomers racing toward—or already in—retirement, the need for retirement income protection has never been greater.
It’s been well documented that since Jan 1, 2011, about 10,000 baby boomers have and will continue to turn 65 each day. This demographic phenomenon forces our industry to be the catalyst in moving clients’ mindset from accumulation to income distribution strategies. Our retiree clients now need to draw down their assets to generate a reliable, secure income stream that will allow them to maintain the lifestyle they so desire during their retirement years.
With the latest gyrations in the stock market, historically low interest rates and the economic turmoil here and abroad still fresh in their minds; clients are looking for less risky solutions to creating a secure retirement income combined with growth potential. Those clients nearing or in retirement can’t afford to weather another pullback in the market as was experienced several years ago. They just don’t have the time horizon or risk tolerance to recover unless they want to continue working throughout their retirement. In addition to market shifts, we are dealing with traditional safe money alternatives, such as CDs, money market funds and saving accounts, that may be out of favor due to these low rates.
Fixed indexed annuities as a solution
All of these forces—demographic and economic—pose an interesting challenge to agents. The major risks facing senior clients today are:
- Market risk—The ongoing volatility in the stock market
- Inflation risk—The erosion of one’s purchasing power
- Longevity risk—The increase in life expectancy
The average individual’s lifespan has increased markedly over the last 50 years, and people now have to worry about running out of money before they run out of time.
A product solution to mitigate these risks that I’ve incorporated in my practice is the fixed indexed annuity. Since their introduction in 1995, indexed annuities have given people the opportunity to participate in the upside of being linked to an index, such as the S&P 500, without having to worry about losing money. Clients are very receptive to the dual nature of this product, which, at its core, is an insurance contract. They get the opportunity to partake in the upside potential of the stock market, with the **guarantee they won’t lose money. In addition, over the years, these products have performed as they were designed to. [Read More…]
Annuity Guys® Video Transcript:
Dick: One of the things that Eric and I find ourselves involved in a lot of times with annuities is laddering those annuities.
Eric: Right. It’s a technique or a strategy that we employ that uses multiple annuities with basically different maturity dates. So you would start with perhaps a three-year or a five-year or a ten-year, different layers.
Dick: I think a lot of folks, Eric, are familiar with CDs. You’re familiar with CD laddering. You may not have called it laddering, but staging your CDs over a period of time.
Eric: Staging or staggering.
Dick: It works very well for annuities for different reasons.
Eric: Right. Well, what are some of those reasons? Safety because you could use three different companies.
Dick: Diversification helps with that safety.
Eric: Right. Then you’ve also got return.
Dick: If you’re wanting to grow your money. We’re in a very low interest rate environment. So what do we think is going to happen maybe over the next three to six to eight years?
Eric: We expect interest rates to rise because they’re at all-time lows. They’re almost at zero in the case of the Fed rate.
Dick: Sure.
Eric: So we expect to see growth. But what do you do now? In order to get the biggest return right now, you have to commit to seven, eight, nine, or ten years.
Dick: It’s a pretty long period of time. Right.
Eric: Is it a smart decision to say, “I want to put all my money in a ten year product right now,” knowing that rates are likely to go up in say three or four years?
Dick: It probably isn’t if you’re looking for growth.
Eric: Right. But are you willing to sacrifice three years of growth just waiting?
Dick: Well, the alternative to that though, Eric, is if we don’t do anything, we get no return at all.
Eric: Well, actually we lose money.
Dick: We lose money because of inflation.
Eric: Inflation.
Dick: Exactly.
Eric: Yeah, exactly. By looking at, in the case of return, staggering those things. Monies are coming due at various intervals. It gives you that. The one thing I like to use annuities for in laddering is the income riders and the income **guarantees.
Dick: Right, which is a completely different way of looking at annuities and using them, but it’s been very effective for our clients.
Eric: The strength of an annuity right now, especially the hybrid annuities, is the **guarantees for income and deferral. You still have the five, six, or seven percent out there that you can get in a deferred for income. If you use a stage one annuity, perhaps turn income on right away knowing that you’ve got this **guarantee in deferral, your stage two or the second rung of the ladder you can turn on.
Dick: This helps us to offset inflation, because we know that, initially, we can start off with an income that would be adequate for that time period, but that we’re going to need to supplement that income five years, eight years, or ten years down the line. The next annuity kicks in at that stage, which is laddered.
Eric: Exactly. The it’s even nice to have an optional rung that may sit out there that you may never even anticipate turning it on. But if you have longevity that you don’t either anticipate or something happens, you’ve got that third one out there that’s in deferral getting those **guarantees. So it becomes that additional rung.
Dick: Right. It can pass on to the heirs, or you can turn it on if you need it. One of the things that we really don’t know right now is what is going to happen to certain pensions, what cutbacks or things might happen with Social Security. So it’s nice to have that contingency, that annuity out there that’s going long term.
Eric: Right, and it’s nice to have one that’s especially geared for growth. You know that it’s going to be at this level here, this level here, and this level here. The **guarantees, having those **guarantees out there.
Dick: When would it maybe not make sense to ladder?
Eric: Not use a ladder? Well, obviously if you have limited assets. There are just times when there are minimum deposit requirements, and if you have limited assets, you may only have an option of one annuity. That’s one.
Dick: Sure. When we say “limited assets,” maybe $100,000 or $200,000, somewhere in that neighborhood? I guess it depends on the income that you need. It depends on the growth that you need.
Eric: Right, it depends on all that.
Dick: I do know that the more money that you have, folks, especially when you start getting up there in the $400,000 to a million or a million plus, it makes a lot of sense to ladder and diversify as compared to maybe below $400,000. There can be some good reasons to still ladder and still diversify, but you have to look at it a little closer.
Eric: Right. One of the things we run into a lot is much of the time you’ll see one specific annuity that performs best for somebody’s situation, and there’s just not another comparable piece that does the same thing.
Dick: So the tradeoff is to get the diversification, the safety, and the laddering that maybe you’re looking for, you have to take considerably less in benefits.
Eric: It’s simply deciding to take a pay cut. If you value the other things you get in the willingness to take a pay cut, that’s what that balance is.
Dick: Then there are, again, some annuities out there, on the growth stage where it’s not just income or the pay cut, where they give a really nice death benefit. On top of that death benefit, they will give a nice return, so that you would maybe have the potential to see somewhere between a 6% to a 10% return from a very safe position with your assets. It may be a situation where a person would say, “Hey, because I want this to go onto my heirs, I don’t really need to ladder it,” depending on the amount of money.
Eric: It’s the **guarantees. You are getting a contractual **guarantee in this case from an annuity that is superior to something else that’s offered by anybody. It’s if you’re willing to take less and go here and split them, that’s an option. If you know your best circumstances lays right here, sometimes you’ll decide not to ladder.
Dick: I would say, just for folks as we kind of wind things up here, that in most cases the laddering is a good thing, works, and should be looked at. Occasionally, though, it’s not. I mean occasionally you’re going to want to go with one company that gives you the greatest benefit, and it isn’t going to make as much sense to ladder.
Eric: The best way to say this is, “You know what? Sit down with someone who can run the numbers for you, talk to them about what the pros and the cons are, and then ultimately you get to make the decision.” Now, I think it should always be one of the things that’s part of the consideration and part of the discussion. For most advisors, that’s exactly how they’ll present it: Here’s option one, here’s option one and two, and here’s how that works out.
Dick: Right. What are you comfortable with?
Eric: Exactly. Where is your comfort level? You’re in control.
Dick: Right. Pick what’s best for you.
Eric: Exactly. Thanks for checking us out.
Dick: Thank you.