Using annuity ladders is very similar to bond laddering: different positions maturing at different times. Annuity and bond laddering can be particularly effective today because of the low interest rate environment. Most of your clients likely realize interest rates are going to increase at sometime in the future. Annuity laddering can be the answer to this concern.
The table shows interest rates paid on fixed-rate annuities; table shows somewhat of an inverse yield curve: 7-, 10- and 15-year rates are lower than 5-year rates. This is not particularly relevant for this discussion, but it is a point of interest.
Annuity Rates [February 20, 2014]
The fact 7, 10, and 15-year rates are lower than 5-year rates means the annuity industry currently believes rates are going to fall. This thinking could change next month or several months from now.
The interest rate paid by annuities is almost always higher than similar-maturing government bonds. For example, 2-year Treasuries have a 0.3% yield (vs. 1.1% for a 1-year annuity), 5-year Treasuries have a 1.5% yield (3.5% for 5-year annuity), and 10-year Treasuries have a 2.7% yield (3.3% for 10-year annuity). In fact, if you go back 12 years, 5-year annuity rates have always been higher than 5-year Treasury rates; the same is true when comparing 10-year annuity rates to 10-year Treasury rates. This has been true for each and every year over the past 12 years.
Annuity Rates vs. Treasury Yields [February 20, 2014]
1 or 2 years
Unlike bond laddering, there is no ongoing taxation of an annuity since interest compounds until withdrawals are taken. The annuity investor can defer income taxes for his lifetime, the lifetime of his surviving spouse, plus an additional 5 years after surviving spouse’s death.
Using a ladder strategy, your client might evenly divide his/her money into three equal parts: one third invested in a 1-2 year maturing annuity, another third in an annuity maturing in 5-7 years, and the final third invested in a 10-year annuity. As each annuity matures, it can be renewed or exchanged for another annuity without triggering a tax event.