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Building an annuity ladder

By Jennie L. Phipps ·
Thursday, January 30, 2014
Posted: 3 pm ET

One of the challenges of retirement planning without an old-fashioned defined benefit pension is the need to devise a strategy for paying yourself regular income.

TIAA-CREF, which specializes in providing retirement plans for government and nonprofit entities, studied worker attitudes toward retirement savings and concluded that most people younger than retirement age have no idea how they will manage their savings to make it last as long as they live.

Dan Keady, director of financial planning at TIAA-CREF, points out that people's vision of how much money they'll need and how long they'll need it is foggy at best. For instance, a third of respondents of TIAA-CREF's new lifetime income survey say they think they will require only 25 percent to 50 percent of pre-retirement income -- an unrealistic measure. Experts think 70 percent to 80 percent of pre-retirement income is a more accurate estimate.

And while 61 percent of savers believe that their savings will have to last 15 years or more, Keady points out that calculating longevity is an inexact science. He says TIAA-CREF is currently making annuity payments to 26,000 people who are between the ages of 90 and 99, and it's paying 500 people who are 100 or older. "You could be one of those long-lived folks," he says.

If your 401(k) has a lifetime income option, Keady recommends that you consider participating in that feature because the annuities offered through it will likely have better returns and lower costs than what you can buy on the open market. If you don't have that option, he advocates that you use 25 percent of your savings to buy an annuity when you first retire -- at, say, 65, while systematically withdrawing no more than 4 percent a year, adjusting annually for inflation, from the remainder of your savings.

At age 70, he suggests you take another 25 percent and buy another annuity. Because you are older, the return on this one will be better. If you are still hale and hearty at 75 or 80, consider buying yet another annuity, effectively locking in some insurance against outliving your money.

This strategy can also help you afford to delay taking Social Security until age 70, when you will qualify for the maximum benefit, he says -- another hedge against coming up short. It can also help protect you if the insurance company selling the annuity fails. Annuities are guaranteed by individual states and some of them have a $100,000 limit.

This strategy requires substantial savings. "If you're saving less than 10 percent of your pre-retirement income, you probably won't have enough for this to work," Keady says.

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1 Comment
Rachel Summit
February 04, 2014 at 2:20 pm

Thanks for sharing this example of the benefits to laddering annuities. Delaying social security until age 70 is a great benefit. It's also helpful to get higher returns as you age. Annuities are one of the only products that help mimic the pension streams of old and are worth a look for part of your retirement savings.