Laddering fixed annuities can prove to be beneficial 2/6/2010 9:44 PM By GREG ROBERTS Columnist
Loading up your retirement portfolio with a big chunk of what are known as single premium fixed immediate annuities may not seem like a good idea with interest rates as low as they are. Right now, a 70-year-old male could get a monthly income of about $7.32 for each $1,000 invested, whereas that same person could have received $8.32 per thousand in July 2000.
The $64 question is: Will interest rates go up or not? But financial experts can't agree on the direction of future interest rates. And that indecision is exactly why it may make sense to consider the laddering of your fixed-income immediate annuities. What this term refers to is the practice of purchasing increments of your required retirement income need periodically in a fixed annuity.
To illustrate the point, assume that a 65-year-old male wants to spend $300,000 on the purchase of fixed annuities, with no residual payments to any of his beneficiaries. If he used the entire $300,000, he would receive $1,946.94 each month. If he were to ladder his purchases at 65, 70 and 75, he would receive $649 per month now, another $731 per month at 70, and finally at 75, another $859 per month, boosting his combined payout to $2,249 per month. The calculations presuppose that everything remains as is - interest rates and mortality.
Granted, the monthly income would be less for the first 10 years, but the dollars that are not annuitized could continue to be invested and earn interest, which could provide some additional income.
Actually, several insurance companies have formed retirement investment groups within themselves to take advantage of this laddering concept. Both The Principal and MassMutual have taken this step, and what happens is that a retiree, or someone approaching retirement, has a retirement portfolio that is invested in some combination of stocks, bonds and fixed annuities.
The study assumes a 65-year old-male wants to retire at 75. His initial portfolio might be 50 percent stocks and 50 percent bonds. Each year, amounts are withdrawn from stock and bond portions proportionately and used to purchase fixed annuity increments. This technique is repeated each year, until all of the retirement income is provided by the fixed annuities that have been purchased over time, rather than all at once.
MassMutual actually performed a study of this technique versus just investing in a combo of stocks and bonds. Each portfolio started with $100,000 for a 65-year-old man, and the results were based on market data from 1980 to 2006. The upshot is that the strategy of purchasing incremental amounts of fixed annuities over time generated the better results.
If one is considering using this laddering technique, it is probably wise to purchase your annuities from several different top-rated life companies. Remember that each state has a guaranty fund to protect policyholders from an insurance company's failure, but if you purchase from a highly rated company, the possibility of failure (insolvency) is very, very slight.
MONEY SAVINGS TIP: If your mortgage balance is less than 20 percent of your home's current value and if you have an unused home equity line in place, it may make sense to pay off your mortgage using your home equity line of credit. In this way, a greater proportion of each payment to your home equity line will go to principal reduction than would have been the case with the mortgage. Also, principal payments that you make will immediately reduce the outstanding principal balance, almost dollar for dollar. Finally, short-term interest rates are below even 15-year mortgage rates.
Got a financial planning question for Greg? You may e-mail him at greg29803@gmail.com.
Greg Roberts is a certified financial planner with 35 years of financial and estate planning experience.
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