One measure by which to judge the crafting of an insurance or financial plan is flexibility: the ability to adjust the plan to meet the changing retirement needs of the client. When considering annuities for the plan, advisors say there may be no better way to achieve that flexibility than to use a laddering strategy.
"Once it's determined that an annuity is an appropriate product for the client, then the idea of using more than one just adds to a plan's flexibility," says Chip Williams, president of Williams Financial Services Inc., Coral Springs, Fla. "It provides the leeway needed to adapt to changed financial circumstances down the road."
Sources say laddering–the purchase of multiple annuities that annuitize at different times during an individual's retirement years–is ideal in part because it allows clients to meet unexpected liquidity needs. An individual can, for example, dip into funds invested in a second, third or fourth annuity that annuitize at staggered 5-year intervals while deriving current income from an immediate annuity.
Deferred annuities that are part of a laddering approach can also stay invested in the equities market after the customer retires, providing potentially greater income in future years than alternative approaches–including approaches relying solely on bonds and equities.
A study by Springfield, Mass.-based MassMutual tested 4 strategies for managing a retirement income account over 181 time periods between 1965 and 2006. It found that the 3 strategies involving an income annuity, whether purchased all at once or over time, generally outperformed the stock- and bond-only strategy, regardless of market conditions.
In that study, the investment-only approach, even during strong equity and bond markets, ran out of money in 25% of cases. In contrast, the strategy of laddering into a life annuity matched the income goal in 100% of cases tested.
"The reason is that when you buy an income annuity, you're building security, but you're using less of your capital to generate the income you need," says Jerry Golden, president of MassMutual's Income Management Strategies Division. "That means more of your capital is available to be invested long-term and to enjoy the returns of the market.
"Also, when you ladder, you're selling mutual funds, and buying annuity income, at different points in time," he adds. "So you're enjoying the effect of dollar-cost averaging.
"And finally, you're buying the income annuity at advanced ages, so you're getting more income at the later ages," Golden says.
Of the hypothetical strategies tested in the MassMutual survey, one called for leaving 50% of funds invested in equities and 50% in bonds. In the second scenario, one-third of mutual funds are sold to purchase an income annuity. In scenarios 3 and 4, the client ladders into, respectively, a life annuity and a life annuity with 20-year period certain.
While the stock- and bond-only strategy preserved the original deposit at the end of each period tested in 45% of the cases, the laddered life annuity strategy preserved the original deposit in 93% of the cases. For the 45% of cases in which the stock- and bond-only strategy preserved the original deposit, the average liquid value of the laddered life annuity strategy was 66% higher.
