Annuity ladder strategy: How to create a steady income

Today’s retirees struggle to balance the need for guaranteed income with the risk of locking in low interest rates. That’s where annuity laddering comes in.

This strategy offers a middle ground between going all-in on annuities and avoiding them altogether. While it won’t work for everyone, it may be a good option for some.

This guide explains what annuity ladders are, their advantages and limitations, step-by-step construction, and ongoing management strategies.

What is an annuity ladder?

An annuity ladder is a retirement income strategy that staggers the purchase of multiple annuities over several years to create multiple “rungs.”

It usually involves fixed and multi-year guaranteed annuities (MYGAs), which offer guaranteed growth for a set term, such as two, three, four, or five years.

“Annuity laddering offers a strategic way to smooth out your income and manage interest rate risk by not putting all your eggs in one basket at a single point in time,” said Bradly Stevens, financial advisor at BAS Financial.

“You’ll get guaranteed income and the flexibility to take advantage of better rates down the road,” Stevens added.

How does an annuity ladder work?

Think of annuity laddering like building a staircase.

You allocate your money across multiple annuities with varying terms. Then, as each annuity matures, you gain access to those funds. At that point, you may renew your contract at current rates or withdraw the money, creating a “rolling liquidity effect.”

Instead of investing $500,000 into one immediate annuity today, for example, you might invest $100,000 per year for five years, with each annuity beginning payments at ages 65, 66, 67, 68, and 69, respectively.

How do annuity ladders differ from other laddering strategies?

Annuity, bond, and certificate of deposit (CD) ladders all provide principal protection and consistent access to funds at different points in time. The primary difference between them, however, is their tax treatment. Annuities are tax-deferred until you withdraw funds, while bonds and CDs require you to pay taxes annually.

Also, annuities may offer higher yields than CDs and can be competitive with bonds. Lastly, while bonds and CDs are designed for liquidity and reinvestment, annuities offer a guaranteed lifetime income opportunity that those products do not typically provide.

What are the benefits of building an annuity ladder?

Annuity laddering offers retirees a strategic balance between income certainty and interest rate risk management while creating gradual income growth.

Here are the most notable advantages of this strategy:

Interest rate risk mitigation

When you buy one large annuity today, you lock in the current rate for the life of that contract.

Through annuity laddering, however, you spread purchases over 5 to 10 years and reduce the risk of buying everything when rates are at historic lows.

Let’s say you purchased a single $500,000 annuity in 2020 when rates were near zero; you’d be locked into those low payouts for life. A ladder strategy would have captured the higher rates of 2022 to 2024.

Keep in mind that while you might miss peak rates, you also avoid trough rates.

Increasing income streams over time

Later annuity purchases typically offer higher payouts due to several factors, including:

• Your advancing age: Older buyers typically receive higher payments because the insurer expects a shorter time frame.
• Potentially higher interest rates: Purchasing annuities at different times allows you to capture changing rates.
• Built-in inflation adjustments: This may help offset inflation.

Let’s say you have $300,000 to invest. You can purchase a single $100,000 annuity at age 60, another $100,000 annuity at age 65, and one more $100,000 annuity at age 70.

Each annuity will begin its income at a different time, resulting in higher income streams than the one before it.

Once all three income streams start, the combined payout would exceed what you’d receive if you purchased a single annuity of $300,000 at age 60.

Psychological benefits and flexibility

When you spread your funds across multiple annuities rather than investing them all at once, you gain greater flexibility and peace of mind. You’ll be able to adjust your strategy as your health changes, interest rates shift, and your retirement needs and expenses change.

Diversification of annuity providers

By purchasing annuities from different insurance companies over time, you’ll be able to reduce counterparty risk. You can shop around for the best rates at each purchase point rather than being tied to one insurer’s pricing.

What are the drawbacks and limitations of annuity ladders?

While annuity laddering offers strategic benefits, it comes with trade-offs, including complexity, costs, and the opportunity cost of guaranteed but potentially lower returns.

Complexity and active management requirements

Purchasing multiple annuities can be complicated. You’ll need to track several products, providers, payment schedules, and tax reports.

Opportunity cost of conservative strategy

Annuities provide guaranteed income, but historically lower returns than diversified market portfolios. However, guaranteed income from annuity laddering offers value in the form of longevity and downside protection.

Inflation risk despite mitigation

While annuity laddering creates increasing income, it’s not true inflation protection. Even with increasing payments, purchasing power can erode if inflation runs higher than your payment increases. Also, purchasing inflation-adjusted annuities (COLA riders) significantly reduces payouts and in turn, might not make financial sense.

Irreversibility and liquidity concerns

Once purchased, immediate annuities generally cannot be reversed or accessed as lump sums. If you experience a health crisis requiring large expenses, for example, you cannot access the principal you’ve committed to annuities.

How do you build an annuity ladder?

Building an effective annuity ladder requires careful planning around your total annuity allocation, purchase timing, product selection, and provider diversification.

Follow these steps to execute it.

Step 1 – Determine your total annuity allocation

Assess your complete retirement income picture, including Social Security, pensions, annuities, and investment portfolios. Then, determine what portion of fixed expenses (housing, food, healthcare, utilities) should be covered by guaranteed sources.

Depending on your situation, you may want to leverage the “bucket strategy,” where you reserve 2 to 3 years of expenses in cash, allocate a portion to an annuity ladder, and invest the remaining amount for growth.

For example, if you determine that $40,000 of your $70,000 annual retirement expenses should be guaranteed, and Social Security provides $25,000, you need an additional $15,000 from annuities. Working backward with life expectancy and rates, you might need $250,000 to $300,000 committed to annuity purchases over your ladder period.

Step 2 – Choose your ladder timeline and rung spacing

There are several timelines you can choose from, including:

• Aggressive ladder (3-5 years): This offers faster deployment, captures the current rate environment more quickly, and provides less dramatic high and low rate periods.
• Moderate ladder (5-7 years): The most common approach, this option balances risk management with a reasonable deployment timeline.
• Conservative ladder (7-10 years): The conservative ladder allows for maximum rate averaging and maintains flexibility the longest, but delays the full income stream.

In addition, you’ll need to make rung spacing decisions, such as:

• Annual purchases: This is the most common option as it’s the simplest to track.
• Semi-annual or quarterly: While the semi-annual or quarterly route is more complex, it can capture rate changes faster.

Step 3 – Select appropriate annuity products

Not all annuities are created equal. That’s why you should shop around and find products that match your unique timelines and goals.

• Choose immediate annuities for near-term income needs.
• Opt for direct income annuities for long-term planning.
• Consider whether you want lifetime payments (most ladders) or period-certain (fixed number of years).
• Explore COLA adjustments, death benefits, and cash refund provisions, but remember that each one reduces payouts.

Step 4 – Diversify across insurance carriers

Choose annuities from multiple insurance companies so you can spread risk and lock in the best rates at each purchase point.

Adam M. Hyers, annuity broker at Hyers and Associates, Inc., recommends purchasing your longer-term annuities from insurers with extra liquidity riders.

“These policies might include nursing homes, terminal illness, annuitization, or other hardship riders. They provide additional liquidity beyond a 5% to 10% free withdrawal, which can come in times of need,” explained Hyers.

As you shop around, keep these pointers in mind.

• Compare quotes: Get annuity quotes from at least five to seven highly-rated carriers at each purchase point. Working with an independent annuity advisor who has access to multiple carriers can help ensure you get the highest payouts.
• Be mindful of state guarantee association limits: These vary by state but are usually between $250,000 to $500,000.
• Find a balance: Balance rate shopping with administrative simplicity as too many providers create tracking complexity.

Step 5 – Execute your first purchase and document your plan

Once you hone in on the right annuities, it’s time to take action. To do so:

• Fund your first rung with the predetermined amount
• Complete all required paperwork with the chosen insurance carrier
• Verify beneficiary designations
• Understand tax reporting requirements (portion of each payment is tax-free return of principal, portion is taxable interest)
• Set calendar reminders for future purchases

Next, document your annuity laddering strategy.

• Create a ladder tracking spreadsheet with purchase dates, start dates, carriers, amounts invested, and projected payment amounts
• Store all annuity contracts in a secure location
• Share your ladder strategy and documentation with your spouse, executor, or financial advisor
• Schedule annual reviews to assess whether to proceed with next rung or adjust the strategy

How do you manage an annuity ladder over time?

An annuity ladder isn’t a set-it-and-forget-it strategy. It requires periodic review and adjustments.

Annual review and purchase decision points

Each year, take the time to evaluate the following:

• Interest rate environment: Are rates significantly higher or lower than expected when you started? If they’ve risen dramatically, accelerate purchases or increase rung sizes. If rates have fallen, pause or reduce rung sizes and wait for them to recover.
• Health status: Declining health might mean reducing future purchases.
• Expense patterns: Are your fixed expenses higher or lower than originally projected? If expenses exceed projections, you might need to increase total ladder allocation.
• Changes to other income sources: Did pension or Social Security amounts change? These types of adjustments may impact whether you want to increase, decrease, or stop annuity contributions.
• Investment portfolio performance: If the market has performed exceptionally, you might want to reduce annuity allocation. Poor market performance, on the other hand, may warrant an increase.

Monitoring insurance company financial strength

Be sure to review AM Best and Better Business Bureau (BBB) ratings annually for each carrier in your ladder. Watch for downgrade warnings or financial stress signals and understand state insurance guarantee association protection limits. Keep in mind that if a carrier is downgraded significantly, you can’t exit the annuity contract but can avoid purchasing others from them in the future.

Is an annuity ladder right for you?

Annuity ladders suit specific retirement profiles but aren’t universally appropriate. If any of the following apply to you, you may want to consider this strategy:

• You’re a pre-retiree between the ages of 55 and 70 with 5 to 10 years before requiring a full income stream
• You have adequate liquid reserves outside the annuity allocation
• You’re concerned about longevity risk due to a family history of long lives, for example
• You have a risk-averse personality and value income certainty over maximum returns
• You don’t have a pension but want a pension-like income
• You’re comfortable with staged deployment and active strategy management

Frequently asked questions