Customize Annuity Options With Laddering

As an agent who has worked with hundreds of clients to help them build and protect their retirement nest eggs, I am now faced with helping my clients make the dramatic shift from the wealth management phase (gathering and growing assets) to the income management phase (preserving and distributing assets). With 78 million baby boomers racing toward -- or already in -- retirement, the need for retirement income protection has never been greater.

It's been well documented that since Jan 1, 2011, about 10,000 baby boomers have and will continue to turn 65 each day. This demographic phenomenon forces our industry to be the catalyst in moving clients' mindsets from accumulation to income distribution strategies. Our retiree clients now need to draw down their assets to generate a reliable, secure income stream that will allow them to maintain the lifestyle they so desire during their retirement years.

The latest gyrations in the stock market, historically low interest rates and the economic turmoil here and abroad are still fresh in clients' minds. They're looking for less risky solutions to creating a secure retirement income combined with growth potential. Those clients nearing or in retirement can't afford to weather another pullback in the market as was experienced several years ago. They just don't have the time horizon or risk tolerance to recover unless they want to continue working throughout their retirement. In addition to market shifts, we are dealing with traditional safe money alternatives, such as CDs, money market funds and savings accounts, that may be out of favor due to low interest rates.

Fixed indexed annuities as a solution

All of these forces -- demographic and economic -- pose an interesting challenge to agents. The major risks facing senior clients today are:

1. Market risk -- The ongoing volatility in the stock market

2. Inflation risk -- The erosion of one's purchasing power

3. Longevity risk -- The increase in life expectancy

The average individual life span has increased markedly over the last 50 years, and people now have to worry about running out of money before they run out of time.

A product solution to mitigate these risks that I've incorporated in my practice is the fixed indexed annuity. Since their introduction in 1995, indexed annuities have given people the opportunity to participate in the upside of being linked to an index, such as the S&P 500, without having to worry about losing money. Clients are very receptive to the dual nature of this product, which, at its core, is an insurance contract. They get the opportunity to partake in the upside potential of the stock market, with the guarantee they won't lose money. In addition, over the years, these products have performed as they were designed to perform.

A challenge, however, in today's marketplace is that the caps and participation rates, which are modifiers used to calculate the returns on these products, are around the guaranteed minimums for new business. The role of the agent is to help the client take all these interest rates into consideration when looking at these products. When interest rates begin to creep up, so will the caps and participation rates. It's also important to remember the fixed indexed annuity is designed to try to achieve a better rate of return than other fixed savings vehicles like CDs, money market accounts and traditional fixed annuities.

Annuity laddering as a retirement income strategy

For my risk-averse senior clients, I also use an annuity laddering approach to incorporate more guarantees into their retirement income stream. Laddering is simply making use of fixed indexed annuities with different durations (five, seven, and 10 years for example) in such a way as to guarantee the income in any given year and a method for bumping up that income stream over time. This approach has really resonated with my clientele as well as new prospects because it addresses market, inflation and longevity risks.

In a recent case, I worked with Bill and his wife Sherry, who are both 60 years old. Bill plans to retire at age 65. We utilized a five-year fixed indexed annuity for some non-qualified money that he had in a CD and a 10-year fixed indexed annuity for a portion of the money he had in his 401(k) doing an "in-service" rollover to an IRA. The plan is for Bill to begin drawing retirement income from the five-year vehicle at age 65 when he retires. In addition, he will still have money in his 401(k) then, and we will position that in an IRA that will provide minimal risk, total liquidity and the opportunity to supplement the income that he will begin receiving from his five-year fixed indexed annuity. Then, at age 66, he will begin taking Social Security benefits.

Finally, at age 70½ he will begin withdrawing retirement income from the 10-year fixed indexed annuity to satisfy the required minimum distribution (RMD). This will provide him with the opportunity to increase his monthly income two times after he begins taking retirement income at age 63. In addition, the fixed indexed annuity is especially ideal for his qualified money, as it will give him the guarantee of knowing that when he is obligated to begin taking his RMD -- even if the stock market performs negatively -- his income is protected for as long as he lives.

Utilizing the laddering approach also allows me to address the anemic interest rate environment we are facing today. By staggering the durations, I can mitigate the interest rate risk associated with any individual fixed instrument. As these annuities come out of surrender, it gives me an opportunity to reposition those assets should something more favorable be available. Everyone's financial needs change over time, so laddering annuities gives the advisor the ability to truly customize a plan to address clients' current as well as future income needs, five, seven and 10 years down the road. The old adage "You never want to put all your eggs in one basket" couldn't be more fitting when it comes to annuities. In addition to staggering durations of different annuities, I also diversify among annuity carriers and contracts. This approach is consistent with the overarching goal of alleviating risk in retirement.

There's been a huge paradigm shift in society from being able to rely on corporate-defined benefit plans for a guaranteed retirement income stream to now having to rely on "personal" defined benefit plans --savings -- to create the money needed to maintain a certain retirement lifestyle. By including fixed indexed annuities in the product tool box of solutions and using a laddering approach as a strategy, agents are now better able to serve the retirement income needs of their senior clients.

Scott Bulmer, M.B.A., is a leading agent with the Oklahoma City branch of the Futurity First Insurance Group. He can be reached at [email protected]. Kevin Hedstrom, assistant vice president, Product Management, for Futurity First, also contributed to this article. He can be reached at [email protected].