Consider Cash Flow Planning With Laddering And Annuities
Lets compare the classic retirement income cash flow planning technique–laddering of bank certificates of deposit (CDs)–with a modified strategy using annuities.
First, heres the classic method: The client buys CDs with maturities that are split among several future years (say, five). The client lives off the income from these CDs, being sure to reinvest the CD principal as each certificate comes due.
Why has this been considered to be a valuable income strategy? Because it reduces risk by carefully matching maturity of investments to projected needs.
The retiree benefits from being farther out on the yield curve. Even now in times of low interest rates, the interest yield curve is about 1.3% higher at five years than one, and 2.0% higher at 10 years.
The strategy spreads out the purchase dates for the CDs, reducing the risks of buying at an inopportune time.
Are there problems today with using this approach? Yes. These include: the interest rates now are very low; the strategy doesnt utilize principal; and the strategy doesnt have growth potential.
Lets look at a modified approach:
Project income needs forward, say five years. (The investments could be CDs, bonds, fixed annuities or any other sensible fixed-income investment.)
Each year, seek to marshal one more years assets to cover one more year. The first year, the money would be invested to mature in year six, in this example. The retiree can choose the timing and source of funds each year, giving some flexibility. High tax basis assets for the new years funding will be most tax-efficient.
This modified approach offers opportunities to invest in equities or anything else, in hopes of achieving better returns long term, while taking on more risk. Note, however, that one would always have a five-year leeway before having to liquidate equities. The next five years are set!
Thinking in terms of asset allocation strategies, this method would start with a fairly even mix of equities and fixed income but automatically and gradually shift over to almost all fixed income by about age 85.
If the client takes this approach with deferred annuities (fixed and variable), then for tax efficiencies, the client would want to have the money in several annuities. But, the producer should be sure the client does not run afoul of government rules requiring the lumping together of annuities bought in one year from one carrier. In short, the modified approach is clumsy with deferred annuities.
