Annuities are insurance contracts, where the issuer agrees to pay you a certain amount of money back (either in installments or a lump sum).
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Retirees typically use them to diversify their income streams once they leave the workforce. Some annuities even pay out for the remainder of your life, protecting you against superannuation (the risk of running out of money before you pass away).
As safe as they sound, most come with inflation risk and interest rate risk. So how can you mitigate those risks as you plan for retirement?
Annuity Ladders, Explained
No one says you’re limited to just one annuity. You can buy as many annuities as you like, just as you can invest in as many stocks, bonds, mutual funds, and real estate investments as you like — which means you can “diversify” your annuities, just as you diversify your investment portfolio.
By diversifying your annuities, you can minimize the risk of weak interest rates and/or high future inflation undercutting your payouts.
That classic model of laddering annuities involves scheduling different maturity dates, so that they each pay out in succession. But just as there are many types of annuities, you have several options to ladder them.
3 Ways to Ladder Annuities
How can retirees set up an annuity ladder? Try these three strategies for laddering annuities.
1. Spread Your Principal Over Time
If you understand the concept of dollar cost averaging your stock investments over time, then you get the idea of staggering your annuity purchases.
At regular intervals, you buy new annuities. For example, you buy a 15-year fixed annuity every year for the next 10 years.
You avoid locking yourself into a low fixed interest rate this way. As interest rates fluctuate over time, you buy higher- and lower-paying annuities.
In other words, you spread out your interest rate risk.
2. Stagger Your Payout Dates
Alternatively, you could buy all of your annuities at once — but spread out the maturity dates.
You start collecting payouts from your annuities when they mature. These payouts could be monthly, or a lump sum, depending on what type of annuity you bought.
The bottom line: you start receiving your annuity retirement payouts at staggered intervals.
3. Buy Different Types of Annuities
There are seemingly endless types of annuities.
Fixed annuities pay a fixed interest rate. Variable annuities pay based on underlying investments you chose at purchase. Indexed annuities pay interest tied to the performance of some underlying index investment (such as the S&P 500), often with a floor or other downside protection.
Immediate annuities start paying interest right now. Deferred annuities grow in the “accumulation phase” then start paying out at maturity.
Some annuities pay for a fixed period of time, others for the rest of your natural life.
You can buy any or all of these types of annuities, to combine the benefits and spread the risk.
Final Thoughts
Annuities can supplement your retirement investments and provide a safety net. But they can also underperform compared to actual investments like stocks, bonds, and real estate.
Learn More: 6 Ways To Lower Expenses in Retirement While Still Living a Luxury Lifestyle
Talk to a financial advisor before buying annuities, to get holistic advice based on your long-term goals and risk tolerance.
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This article originally appeared on GOBankingRates.com: How Does an Annuity Ladder Work and Is Right for Your Retirement Strategy?
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