Hedge Bets With an Annuity Ladder

EDITOR'S NOTE: This article, which has been updated, was originally published in the March 2012 issue of Kiplinger's Retirement Report. To subscribe, click here.

Low interest rates are great if you are borrowing money, but not if you are trying to generate income. So if you're in the market for a fixed immediate annuity, you probably were not pleased by the Federal Reserve's recent announcement that it plans to hold its key benchmark short-term interest rate near zero until late 2014.

Buying an annuity at these low rates will lock in a lower lifetime payout. But if you like the security of guaranteed payments and you believe interest rates will rise down the road, you can hedge your bets by laddering annuities.

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As with ladders of bonds or certificates of deposit, you don't buy a single annuity that sets one rate for your lifetime. Instead, you split your money among several annuities over a period of time.

For people in their early sixties, "break it up into three pieces," says Drew Denning, vice-president of income management solutions at Principal Financial Group, with the purchases separated by three to five years, or even longer. Clients in their early seventies or older, he says, should shorten the purchases to every two years in either two or three chunks.

Today's payouts for fixed immediate annuities are relatively low. A 70-year-old male could recently get an average monthly payout of $6.50 per $1,000 invested, compared with $8.32 in the summer of 2000.

Even if interest rates don't rise, laddering will enable you to capture higher payments because of your age. "Payouts will be higher even if interest rates are the same," says Denning.

How does laddering stack up against one large purchase? Say a 65-year-old man in Virginia wants to spend $300,000 on annuities. If he buys a $300,000 lifetime annuity at 65, he'd receive $1,737 a month, according to a recent quote on ImmediateAnnuities.com.

Instead, he could buy a lifetime annuity for $100,000 now and get $579 a month, forgoing some guaranteed income. At 70, he buys another $100,000 annuity to get an extra $663 a month. He buys his third $100,000 annuity at 75 to get $786 a month, boosting his combined payout to $2,028 a month. This assumes that interest rates and life expectancies remain the same.