An annuity ladder basically involves spreading annuity purchases over time.
For example, instead of taking $100,000 to purchase an immediate annuity today, a person might purchase five different $20,000 annuities over a seven year period.
This approach has a number of advantages:
- The approach helps avoid the risk of purchasing an annuity at a less then optimal time--for example when interest rates are very low. In this sense, it is somewhat similar to dollar cost averaging when investing.
- The approach helps address credit risk by spreading a larger annuity purchase among various insurers.
- Locking-in guaranteed income through annuities helps to address market risk and sequence of returns risk.
- The approach helps to maintain more liquidity than would otherwise be available through a single annuity purchase.
- Funds not used to purchase annuities may be used more aggressively once the ladder is complete.
A recent study from the Wharton School suggests that an annuity ladder might be more helpful than conventional investment approaches in meeting retirement objectives:
In a recent study entitled Variable Payout Annuities and Dynamic Portfolio Choice in Retirement, Olivia Mitchell, a professor of insurance and risk management at the Wharton School of the University of Pennsylvania, argues that by laddering the purchase of annuities-buying annuities gradually over time, while keeping the rest of a portfolio invested in a mix of equities and bonds-people can substantially increase the likelihood of meeting their retirement income goal.
The views expressed in the Wharton study are supported by other industry experts:
"Annuity laddering using payout annuities is particularly effective relative to investment-based strategies," says Chris Rahm, leader of the retirement income practice at Ernst & Young. Rahm notes that with the annuities acting as a client's most conservative investment, "if you were an aggressive advisor, you could argue that the client could move more invested assets into equities."
Source: Financial Planning
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