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Laddering Fixed-Rate Annuities Offers Rates That Beat Bank CDs, Plus Flexibility

With today’s low interest rates, it takes planning to create sufficient retirement income without taking more risk than you need to.  The days when you could get good income from a collection of Treasury bonds are long gone.

You can get income from dividend-paying stocks, bank accounts, bonds and bond funds, and several different types of annuities.

Each has pros and cons. Stocks that pay high dividends can yield a good amount of income, but stocks can be volatile. You can lose money, and if you’re retired, you may not be able to wait until the market recovers. 

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Guaranteed deposits, such as bank CDs and fixed-rate annuities, may pay less, but both the interest income and principal are assured (although in different ways).

Most retirees use a portfolio of products and strategies. By mixing and matching appropriately, you can produce income, counteract inflation and provide some liquidity that you might need for anything from medical expenses to a great vacation or giving money to kids or grandchildren. 

The right mix is highly individual.  Retirees with pensions that cover the bulk of their monthly expenses may be able to take more risk with their money.  Others who don’t have that cushion and can’t afford to lose anything look to guaranteed strategies.

How Fixed-Rate Annuities Work

One type of guaranteed product is the fixed annuity.  A very popular option today is the multiyear guaranteed annuity, or MYGA. Underwritten by a life insurance company, it acts much like a bank certificate of deposit (CD). You deposit a lump sum, called a single premium. You then receive a set interest rate for a set period. 

Unlike bank deposits, fixed annuities are not FDIC-insured. However, there is a form of insurance provided by state guaranty associations in case the insurer becomes insolvent. Coverage varies by state. 

Annuity interest is tax-deferred until withdrawn. If you receive income from an annuity before age 59½, you’ll normally be hit with a 10% IRS penalty in addition to ordinary state and federal income tax.  

Fixed annuity features vary.  If you’ll be relying on an annuity for income, make sure that the product you’re considering allows either monthly or annual interest withdrawals, depending on your needs and preferences.

While these products often allow withdrawals of up to 10% annually, they do levy penalties for taking excessive withdrawals before the guarantee period is over. 

Laddering Fixed-Rate Annuities

A big advantage of fixed-rate annuities is that they usually pay higher rates than other fixed-rate instruments, such as CDs and investment-grade bonds.  As with CDs and bonds, you’ll get a higher interest rate if you’re willing to tie up your money for a longer period.

But is it worth it? On the one hand, “going long” will produce more current income. Some people are comfortable with that. 

On the other, going short gives you flexibility. If interest rates improve in the interim, you’ll be able to get a better rate once the guarantee period is over.

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So, what makes the most sense?  For people with enough money to spread among different annuities, I suggest laddering guarantee terms. Because no one knows for sure which direction interest rates are headed in the future, laddering makes the most sense. It gives you both good current income and future flexibility.

What’s the best laddering strategy? It depends on what the interest rate curve looks like at the time you’re creating the annuity ladder.  If the curve is flattish, going mostly short would make sense.  If it’s steep, you might want to commit more to longer terms.

Today, I recommend laddering annuities from three to five years. Here’s why: 

First, there is a significant interest-rate bump when comparing two- and three-year terms. For example, currently (January 2022), you can earn 2.00% on a two-year annuity from an insurer rated A- for financial strength by A.M. Best.  

With a three-year MYGA, you can earn 2.50% from that same A- rated company. That’s 25% more interest.  Unless you’ll need all that money two years from now, it’s probably worth going for an additional year. 

Three years from now, you’ll be able to roll the proceeds tax-free, via a 1035 exchange, into any other annuity that looks most attractive then.  Maybe rates will be higher.

While a four-year annuity is an option too, five years is a sweet spot.  Even if you’re willing to tie up your money longer, you won’t get much more interest with a seven- or 10-year contract right now.

For instance, as of February 2022, if you’re willing to go with a B++ rated company, you can get 3.15% on a five-year contract with limited liquidity.  You’d get only a bit more, 3.20%, with the same insurer’s seven-year annuity.

If you prefer an A- or better rated company, you can earn 3.00% on a five-year annuity and 3.15% for seven years.

Fixed Annuities for IRAs

Besides being useful for nonqualified savings, fixed annuities also work well for IRAs.  And the same laddering approach works.

Between the ages of 59½ and 72, you may take taxable interest withdrawals from a traditional IRA annuity, or you can let the interest compound and defer taxes.  At 72, you must begin taking required minimum distributions (RMDs). 

If you’re already taking RMDs or soon will be, look for an annuity that lets you take out your RMDs without penalty. Many issuers have that feature. 

If you have all of your IRA in equities or even long-term bonds, you may be forced to make an untimely withdrawal when the stock or bond market is down. Whether you choose a three- or five-year or other term annuity, you’ll be assured that you’ll have the guaranteed withdrawals to pay your RMD.

Annuity expert Ken Nuss launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities. A free quote comparison service with interest rates from dozens of insurers is available at https://www.annuityadvantage.com  or by calling (800) 239-0356.

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Create Your Own ‘Retirement Symphony’

For lovers of classical music, there is nothing like the sound of a great symphony orchestra. It’s amazing to see a finely tuned group of musicians bring together the many different tools of their craft, including brass, woodwinds, strings and percussion, for the purpose of creating music that moves and inspires. Playing each instrument on its own may be nice, but, when brought together to work in concert with each other, the sounds can be amazing!

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You can make YOUR retirement AMAZING by thinking about your plan in the exact same way. Over the years, you may have created your wealth by being a diligent saver and deferring many of life’s pleasures. You may have accomplished this by using a wide array of investment and insurance tools, such as company 401(k)s, IRAs, brokerage accounts, real estate, life insurance, annuities, CDs, etc.  Over time, you probably watched your net worth grow as the values of these tools individually each increased. However, as you prepare to cross that bridge into the retirement phase of life, you will be left to figure out how each of these “financial instruments” should be played together, to create your own “Retirement Symphony.” 

Here are three steps I encourage you to take to get your concert started:

1. Get in tune with a ‘Retirement Mindset’

This can be one of the most important foundational things you can do as you prepare for this journey.  Understand that if you created significant wealth throughout your career, you probably did so with an “Accumulation” mindset, focusing the majority of your efforts on being a regular saver and strategic investor using a wide array of tools and products. 

When you cross that bridge into retirement, however, your mindset should change from one of “Accumulation” to one focused more on the “Preservation and Distribution” of that wealth.  Investment growth is still a part of the equation, given that retirement could last over 30 years.  However, you should expand your thoughts beyond just investment strategies to thoughts about strategies to address a combination of things, such as:

  • Creating monthly income.
  • Preserving wealth that can last your lifetime.
  • Preparing for the high costs of care as you age.
  • Customizing your legacy.
  • And preparing for the possibility of higher tax rates in the future. 

2. Get to know your ‘Instruments’

It’s important to understand the capabilities of ALL your financial instruments and how you can maximize the positive things they were designed to do.  For example, ask yourself what you want from each of your investment accounts going forward. Is your goal to just get a specific rate of return each year because it looks good in traditional retirement planning simulations, OR is the growth you seek for a specific purpose? Those purposes could be for such things as immersing yourself in all your recreational “bucket list” adventures you’ve been dreaming of or just growing a portion of your wealth enough to reach your legacy goals.

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What about some of the insurance tools that you own? Do you understand how to maximize the capabilities of all the various annuities and life insurance policies you purchased over the years? Some examples for using these tools may include creating a lifetime stream of monthly income or having money that can be distributed tax free. In addition, these tools could also be an unknown way to pay for the cost of long-term care or provide the opportunity to leave a significant legacy to loved ones.

Whatever your desires are, understand how to maximize your financial instruments to create those sweet sounds.

3. Work with the right ‘Conductor’

With any award-winning symphony orchestra, the right conductor will certainly be the centerpiece to bring all these sounds together. Without them, perfection cannot be achieved. The same can apply to having the right person to be the “conductor” of your retirement symphony. 

If you have never worked with a financial adviser, the first thing you will need to determine is “when” and “if” you will relinquish the responsibility of your retirement plan design and oversight to someone else. For those who have grown their wealth on their own, this can be a difficult decision. However, ask yourself if you have the desire AND capacity to take on this responsibility as you get older. You may have enjoyed investing money and watching the market over the years, but are you ready to oversee the “Preservation and Distribution” phase of life? 

Once you have decided to hire a financial adviser, finding the right one is next.  Because the financial services industry is filled with thousands of advisers, here are a few things to consider:

  • Are they a fiduciary?
  • Does the adviser/firm specialize in retirement-specific planning?
  • Is the relationship planning-focused or product-focused?
  • How are they compensated for their services?

These are just a few of the many things to consider when determining who will be your  conductor … too many to list here!

Use these steps to begin creating your own sweet music and “Retirement Symphony.”

Investment Advisory Services offered through Trek Financial, LLC, (Trek) an SEC Registered Investment Adviser. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed, and past performance is no guarantee of future results. For specific tax advice on any strategy, consult with a qualified tax professional before implementing any strategy discussed herein.
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