If you’re like many advisors today, you may be searching for a new strategy that will help you solve the retirement income puzzle for your clients. The answer for many advisors and their clients could be a process called retirement annuity laddering. It involves incremental purchases of annuity income with assets transferred over time from equity and bond investments.
Retirement annuity laddering can help the client achieve their desired level of guaranteed lifetime income more often than other commonly adopted strategies. It can also develop more liquidity to address other retirement needs, such as medical costs, and can help build more long-term wealth.
How it works
Retirement annuity laddering embraces an emerging approach to retirement income that recognizes that wisely structured retirement income accounts should incorporate three asset classes — equity and fixed income investments along with an immediate annuity — not just the traditional two asset classes.
A study conducted by the Income Management Strategies Division of MassMutual compared four methods of managing a retirement income account over 181 time periods starting in 1965. They found that the three strategies involving an income annuity, whether purchased all at once or over time, generally out-performed the stock-and-bond-only strategy. In fact, the investment-only approach — even during historical strong equity and bond markets — ran out of money in 25 percent of the cases when compared with a hypothetical purchase of an immediate annuity upfront.
The winning strategy in the study, however, was one in which the retirement income account was laddered into life-only income annuities. This strategy matched the study’s income goal in 100 percent of the time periods tested and preserved the initial deposit in 93 percent of the periods.
Retirement annuity laddering may:
- Give a client more income security than simply investing savings and drawing on them year after year for income
- Provide more flexibility than simply buying an income annuity in a lump sum, which can limit a client’s options if unexpected needs or emergencies arise
- Enable clients to create wealth over time so they have resources at later ages when medical and long term care issues are more likely to occur
- Help smooth out interest rate and market spikes or dips over time in the early years of retirement
- Discipline clients to purchase income annuities at increasingly older ages with the possibility of increased income payout rates (income annuities pay out higher amounts when purchased at older ages)
Perhaps most importantly, the strategy can give retirees the comfort of knowing that they have a plan in place to reach their basic needs and expenses in retirement. Thus, the strategy should appeal to clients who have a gap between the essential expenses they must meet during retirement and the secure sources of lifetime income from Social Security and pensions. Further, these are clients who value flexibility, as well as the potential for long-term liquid funds.
The retirement annuity laddering strategy, however, can pose challenges for advisors in implementation, record-keeping, and ongoing management. For example, coordinating the transfer of savings from mutual funds to the purchase of multiple annuities, managing multiple contracts, and generating multiple income checks for the client could be unappealing.
However, these challenges can be addressed through bundled accounts that are being developed for the advisor market that make the strategy easy to execute while also providing the ability to plan, re-plan, and manage the account. For example, these solutions will feature model mutual fund portfolios into which retirees can invest their qualified retirement savings, then transfer those savings over time into an annuity capable of receiving multiple premiums. The account will generate one income check for the retiree and one statement tracking both the mutual fund portfolios and annuity payouts. Planning software will help the advisor make recommendations to the client on a continuing basis.
At a time when large numbers of retirees are concerned about the security of their incomes, this group is increasingly willing to trade liquidity for guarantees; this could be a mistake. A trade-off of this nature might not be necessary, however, if the client pursues a laddered income annuity strategy. Using this strategy, they can manage both guaranteed income and long-termliquidity. As a result, you can help keep many retirees from making compromises that they simply may not have to make.
Jerome S. Golden is president of the Income Management Strategies Division for MassMutual Financial Group. He can be reached at email@example.com.