Building Bond Ladder Vs. Immediate Annuity

 Bond Ladder Vs. Annuity

A bond ladder is one of the most straightforward income strategies to give a yourself a cash flow in each year of retirement. Just buy a series of bonds that will mature

for the desired amount of spending in each year of retirement. Ideally, the payments are secured to an advanced age in case you live a long time.

In the case of a lifetime annuity, on the other hand, the time horizon is known, at least in the aggregate because, with enough people, the mortality rate actually becomes highly predictable, even if it isn’t known exactly which people will pass away from one year to the next.

In the early years of a bond ladder, payments will be primarily interest on the bonds and just a little bit-of principal, and by the end almost all of each outbound payment will be principal, the early payments are funded primarily by interest and the later ones increasingly from principal.

The drawback of this bond laddering approach is that you truly do not know how long you are going to live.

At the most basic level the value of using an immediate lifetime annuity to fund retirement income is

that it solves for the challenge of the unknown time horizon and uncertain mortality by relying on the law of large numbers to create a predictable time horizon for an aggregated group of retirees.

One of the classic caveats to annuitization is the fact that assets, once annuitized, have no remainder value to leave to one’s heirs.

While some people will purchase an immediate annuity and live a long time – receiving their original principal and then some in return – others will make the purchase and then die unexpectedly, forfeiting what might have been a significant amount.

The bottom line is this: For a given time horizon, annuities have the potential to produce greater payments than can be achieved from a fixed portfolio alone – even if the annuity company invests the funds in the exact same manner – due to the presence of mortality credits.

I’ve included two videos to help explain the concepts of laddered bonds and immediate annuities above, take a look.

Daniel F. Iuculano, AAMS CMFC

Accredited Asset Management Specialist

Chartered Mutual Fund Counselor

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