Why Laddering Annuities May Not Work

Waiting to buy an annuity doesn’t guarantee a better payout.

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Annuities, for the most part, can offer the peace of mind of never running out of money in exchange for giving up the chance to leave a substantial inheritance to your children. But due to the low interest rate environment, many experts are suggesting that you divide the total sum allocated to annuities into chunks in order to take advantage of the likely higher interest rates in the future. On paper, this makes absolute sense. You'll reap the benefits of a higher interest rate and benefit from your then older age, as insurance companies are willing to pay out a higher monthly amount to people they have to make fewer payments to. But the calculus isn't actually so simple. Here’s why separating the annuities isn’t a complete slam dunk:

Your remaining portfolio value can decline so much you won't be able to afford more steps on the ladder. One of the primary reasons to get an annuity in the first place is to reduce the damage portfolio volatility can do to your standard of living. If a severe bear market hits, the sweeter terms of an annuity may not make up for the reduced amount you are able to afford to buy.

Interest rates may stay low for a very long time. It might seem like interest rates have nowhere to go but up, but experts have been predicting higher interest rates for years. It's true that interest rates are lower than the historical average, but there's no rule that says rates will rise in the near future. And interest rates could certainly still go down from here. If interest rates stay the same going forward your plan to wait may not work out as well as you hoped.

Longevity is likely going to continue to increase. The growing life expectancy will only nudge insurance companies to knock down annuity payments even more as they adjust the payout formulas. It’s very possible that any increase in interest rates could be offset by the aggregate population living longer, especially when you factor in the missed payments of waiting to buy an annuity.

The higher payments later may not be worth the additional stress of dealing with portfolio volatility. Remember how you felt about your wealth during the last bear market? Now imagine being retired and only having portfolio assets to live on. Can you handle seeing your money make 5 percent swings on a daily basis when your standard of living is directly and immediately affected?

The cognitive ability and energy necessary to find the most optimum pricing isn't guaranteed as you age. You can find the best pricing available today at these low interest rates, or you could delay and hope there will be better deals for you in the future. But as you get older and become less alert, will you still have the ability and inclination to find that better deal years down the road? You might be able to do it, but are you willing to bet a good portion of your life savings on it?

I only recommend single premium immediate annuities because of the relatively lower fees, but I do think annuities can be extremely useful in eliminating the biggest financial risk retirees face: running out of assets. But think carefully before you decide to give up your life savings for a near guarantee of lifetime monthly payments, and scrutinize every detail, especially if you decide to build a ladder of these payments.