An Annuity Ladder May Help You Ease Into an Annuity Purchase

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What exactly is an annuity ladder?

An annuity ladder simply means to purchase a series of annuities over time. Instead of spending your lump sum on one annuity which locks you into one rate, you split your premium across several smaller annuities over time. Perhaps you buy one annuity every year for five years, or one annuity every two years over the next 10 years.

With an annuity ladder, you're kind of betting on both sides, since nobody knows whether interest rates are headed up or down. Even the best financial analysts can only make well-reasoned guesses, and, as you may have noticed, their opinions vary widely.

Annuity laddering also provides a psychological benefit. It may be easier to spend a smaller amount now on an annuity knowing you've held onto the bulk of your investable assets for a possible higher rate.

Annuity laddering can be applied to both deferred multiyear annuities and immediate annuities.

Deferred multiyear annuity ladder

A deferred multiyear annuity is similar in some ways to a certificate of deposit without FDIC protection. Let's say you have $200,000 to invest at a fixed interest rate and you've determined that a multiyear annuity makes financial sense.

Instead of buying one large annuity with the whole $200,000, purchase several smaller ones each with a different maturity date. This way you can rollover each one or convert it to income as it matures.

How would you do this? You'd divide the $200,000 premium by four and invest $50,000 each in four annuities with staggered maturity dates: ten years, seven years, five years, and three years.

Then at the end of three years, when your first annuity matures, you can roll it over into a higher-yielding contract (if rates have moved up). Hopefully, you can do the same with the other three annuities as each matures.

Immediate annuity ladder

The concept of laddering also works for immediate annuities. Say you wanted to buy a $200,000 SPIA but were ambivalent because rates seemed low. Instead of buying one $200,000 annuity, divide the lump sum into four buckets.

Spend $50,000 today and again every two years until you've used up the $200,000. By laddering this purchase, you'll forgo the extra guaranteed income early on. But the money that's not annuitized could continue to be invested in the markets or in a more conservative account until you're ready to buy your next annuity.

The potential to buy in at higher interest rates is only a part of the benefit of laddering an immediate annuity. It may also allow you to capture higher payments because of your age.

So if rates should move up while you're waiting, you'd get even more bang for your buck since you're older at each purchase. The older you are, the greater the income you receive per dollar invested with an immediate annuity.

So what can go wrong with an annuity ladder?