My sister is an avid cycler. It’s actually her favorite way to exercise. As an older sibling, however, I get nervous about her safety. Generally, speaking cycling is incredibly safe. Plus she takes the proper precautions, such as wearing the right gear and being in the right road position.
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Despite this, she did have a serious accident where she accidentally hit a pothole. As a consequence, she flipped over and fractured her wrist. The moral of the story? Despite our best efforts, the risk is always lingering in the shadows.
And, this is definitely true when it comes to investing your hard-earned money in annuities.
Generally speaking, annuities are one of your safest options when it comes to investing. But, they’re not 100% risk-free. The good news? You can use the following three ways to invest without risking money with an annuity.
Work with the right provider.
“Annuities aren’t backed by institutions like the FDIC,” explains John Rampton, founder, and CEO of Due. “They’re also supposed to last you a lifetime.” That’s why you should only work with an insurance company that’s committed to your long-term interests.
How can fund such a company? The first thing you can look for is a high rating from a third party such as A.M. Best, Moody’s, Standard & Poor’s (S&P), and/or Fitch.
Here are some other considerations that Rampton suggests;
- How easy it is to signup, fund, and access your balance.
- The level of customer service and what you expect in terms of payments.
- Payout interest rates.
However, since your time is valuable, we’ve compiled a list of the best annuity companies available. Each one of them meets the above criteria. “And, we’ve even broken the list down into the best fixed, fixed indexed growth, MYGA, variable, and registered index-linked annuities so that you can quickly find the right type of annuity for you,” he adds.
In addition to working with the right annuity company, you also must choose your salesperson wisely.
“Since your broker has to put food on the table, they’ll earn a commission from annuity sales,” states Rampton. Sometimes these costs are not disclosed. Ask them how much they’ll make on the sale. “And, more importantly, that they’re not selling the wrong annuity just to cash in on a commission.”
Not convinced that this is a problem? One study found that one in twelve financial advisors has been disciplined for serious misconduct.
”These things are not frivolous,” says Mark Egan, an assistant professor of finance at Harvard Business School and a co-author of the study. “The average settlement is in excess of $100,000 and the median is $40,000. These are costly offenses.”
If you decide to buy an annuity, you need to do your due diligence and be just as thoughtful as you would with any other important life decision. After all, while annuities aren’t as risky as other investments, like stocks and bonds, there are still inherent risks involved.
Is it possible to completely avoid these risks? Not always. However, you can drastically reduce any financial risks by diversifying your annuity.
By balancing annuities with stocks, bonds, and cash, you create a well-balanced portfolio. Your money is then protected from market volatility, inflation, taxes, and even medical expenses. Furthermore, a combination of variable and fixed annuities can generate additional income in retirement.
How to diversify annuity.
More specifically, though, here’s how you can properly diversify your annuity;
- Company. Let’s say you have $500k to invest in annuities. Ideally, you should spread your money among two or three companies. That will decrease your risk for each particular company in case one goes belly-up.
- Annuity type. You can also diversify between various types of annuities so your eggs aren’t all in one basket. Short-term MYGAs can be paired with longer-term index annuities, for example.
- Crediting method. Crediting allows you to diversify your index annuity investments. An index annuity that performs well amid market conditions can be found with this method. Moreover, you’ll be able to average out your return by distributing it evenly.
- Index. You can also diversify your investments through index annuities.
- The month of purchase. You don’t want all your index annuities to mature at once when it comes to index annuities. One way to accomplish this is to buy more than once each year. Thus, your gains will be locked in at different times.
- Guarantees. You can simultaneously hold guaranteed and non-guaranteed options. Additionally, you can own both a fixed annuity and an index annuity at once.
Additionally, to determine whether to include or exclude an annuity from your portfolio, determine how the current interest rate environment will impact your retirement income.
Above all, don’t panic. Your long-term financial plan and the diversification strategy you’ve built should fair well against any storm. As such, don’t let external factors, like click-bait headlines or short-term market volatility, throw you off track.
Build an annuity ladder.
“Many investors are familiar with bond ladders or CD ladders, and might already have these types of strategies in their retirement plan,” writes Stan Haithcock, aka Stan the Annuity Man. “Laddering annuity contracts is a new concept to most people, but you should definitely be aware of these unique strategies for both lifetime income and principal protection.”
Laddering for yield.
“Bond and CD (Certificate of Deposit) ladders try to achieve an overall higher yield by staggering maturities so that you have money maturing at different time intervals,” notes Stan. “The hope is that when a specific tranche of money matures, you can lock that money into a higher rate for another specific period of years.”
MYGAs (Multi-Year Guarantee Annuities) is the annuity industry’s equivalent of CDs, he adds. You decide how long you want an interest rate locked in. “Both have no annual fees and no moving parts, and the interest rate is contractually guaranteed.”
MYGAs are often called “Multi-Year Guaranteed Annuities” or “Fixed Rate Annuities.” They’re also very similar to bonds, where you peel off the interest without touching the principal.
- Fixed-rate ladder. “The most popular annuity laddering strategy for yield is what I call a ‘Fixed Rate Ladder.’” For instance, you would buy $100,000 in a three-year MYGA, $100,000 in a four-year MYGA, and $100,000 in a five-year MYGA. In year 3, you would have money maturing every year to increase the interest rate.
- Mixed fixed ladder. A “Mixed Fixed Ladder” is a method of annuity laddering using MYGAs and Fixed Indexed Annuities (aka: Fixed Index Annuities, FIAs, or Indexed Annuities) together. This is the same strategy as the “Fixed Rate Ladder” mentioned above. “For example, with a $400,000 total, you would put $100,000 into a 3-year MYGA, a 5-year MYGA, a 7 year FIA, and a 10 year FIA,” he clarifies. “The MYGA yield is contractual, and the hope is that the FIA returns will be a little higher than comparative duration CDs.”
Laddering for lifetime income.
By now, you should know that annuities can be laddered for both yield and income. “Annuities are the only financial product on the planet that can guarantee a lifetime income stream regardless of how long you live,” he states. “It’s a transfer of risk strategy and financial monopoly that only annuities have.”
As you begin receiving payments, your “income annuity” is largely determined by your life expectancy at the time, with interest rates playing a secondary role. Known as lifetime annuities, income annuities provide a fixed income flow for life and can provide needed cash flow and a guaranteed income. And, it can also be combined with other retirement sources like Social Security and pension.
“There is no ‘best laddering income annuity strategy’ out there, so let’s look at 3 of the most popular ones currently being used,” adds Stan.
Ladder the purchase.
When you are nearing retirement or don’t want to commit to a large lump sum, it makes sense to buy annuities over time. As an example, if you wanted to invest $300,000 in a Single Premium Immediate Annuity (SPIA), you could buy a $100,000 SPIA each year for three years.
Ladder the state date.
It’s also possible to ladder the income start date as well. “For example, taking that same $300,000 example to place in a SPIA, you could buy 3 separate $100,000 annuities at the same time with different income start dates,” he says. “The first $100,00 SPIA would have income start in 30 days from the policy issue date.” With the second $100,000 SPIA, income would begin in one year, and with the $100,000 DIA (Deferred Income Annuity), income would begin in two years.
As the name implies, “this is a combination of laddering the purchase date and laddering the start date.” For example, if you bought a $300,000 annuity, you would begin receiving income after one year. An additional $100,000 annuity will be purchased a year later, with income starting in three years. In the third year of the annuity, $100,000 is purchased with income starting in five years.
“The bottom line is that income annuity laddering is customizable to your specific situation and goals,” says Stan. “And because annuities are contractual guarantees, it’s all math.” Ultimately, the goal is to build the ladder based on your specific needs, which will also reduce financial risk.
Article by Deanna Ritchie, Due
About the Author
Deanna Ritchie is a financial editor at Due. She has a degree in English Literature. She has written 1000+ articles on getting out of debt and mastering your finances. She has edited over 40,000 articles in her life. She has a passion for helping writers inspire others through their words. Deanna has also been an editor at Entrepreneur Magazine and ReadWrite.