Living off your CDs? Ladder Annuities for Potentially More Income

If you are 70 and living off your income from a Certificate of Deposit (CD) you may find it more advantageous to switch to a laddered set of annuities for more income. Let’s consider how.

Laddered Annuity Asset SPIA  5 year Certain Fixed or indexed SPDA 1 Fixed or Indexed SPDA 2 Fixed or Indexed SPDA 3 Fixed or Indexed SPDA 4
Accumulation period (yrs) 0 5 10 15 20
Premium Amount $20,000 $20,000 $20,000 $20,000 $20,000
Assumed Accumulation Interest Rate N/A 3.75% 3.75% 3.75% 3.75%
Current Annual Income $4128 $750 $750 $750 $750
Current Taxable Income $128 0 0 0 0
Net annual income @25% tax rate $4096 $750* $750* $750* $750*
Future Value at end of accumulation period 0 $24,042 $28,900 $37,741 $41,763
Estimated annual income for 5 year term payout N/A $4,968 $5,976 $7,800 $8,628
Estimated annual income for lifetime payout N/A $2,424 $3,528 $5,676 $7,860

*Not currently taxed is this interest accumulates tax deferred in the annuity. For 2010, the 25% tax bracket applies to single filers with taxable income from $34,000 to 82,400 and marries joint filers with taxable income from $68,000 to $137,300.

A $100,000 five year CD hypothetically paying[1] 3.25% gives you an annual taxable income of $3,200. At a 25% income tax rate, you are left with $2,437. Of course you are also left with your $100,000 too. If income rates increase, your net income will too – and vice versa.

But if you need more income, and you do not want to get locked into any current income rate, you may consider investing your $100,000 into a set of annuities. Laddering these (i.e. stagger when each kicks in) allows you to follow income rates if they go up (or down).

Laddered Annuities Option

We will assume you are 70; and with your $100,000, you buy five annuities each for a single premium of $20,000. The first will be a Single Premium Immediate Annuity (SPIA) for a 5 year payout term. The four others will be Single Premium Deferred Annuities (SPDA) geared to produce a payout after 5, 10, 15, and 20 years, respectively. Let’s consider what sort of income you would generate in this case. Refer to the table. These are hypothetical examples and all fees have been ignored (typically, there are no purchase fees with fixed annuities; surrender charges may apply).

You can see under the SPIA five year certain payout[2] that you’d receive $4,128 income giving you an after tax (25% income tax rate and a 97% exclusion ratio applicable to a five year certain payout) of $4,096. This beats out your CD net income, although all the money in this SPIA is gone after five years. But, you are still accumulating savings in all the other SPDAs.

I have assigned a hypothetical accumulation for the other deferred annuities of 3.75% based on current rates in effect as of this writing.[3] And I have kept the rate constant over time as a neutral scenario. Increasing (decreasing) rates would affect both the annuities and the CDs together.

You can see what the (neutral) projected values of the 5, 10, 15, and 20 year SPDAs would be when they become due as you turn 75, 80, 85, and 90, respectively. Along with these values are the projected income they would produce[4] (based on current payouts) for both a five year term payout and for your remaining lifetime – if you chose the latter.

As you approach age 85, you may decide to choose a lifetime income from the next SPDA, and leave the remaining SPDA as a legacy for your beneficiary.

Give us a call so we can show how to potentially increase your income but still have the option of leaving a legacy.

Note: With tax-deferred investments, income taxes may be due upon withdrawal of funds, withdrawals prior to age 59½ are subject to a 10% penalty, the rate of return above is hypothetical, and does not reflect the return of a particular investment and the values shown should not be used to project future income. This table refers to hypothetical investments only and is not indicative of a guarantee of any particular investment results. There are no fees or expenses in the annuity illustrated, but if they were present, they would reduce performance. Earnings withdrawn from an annuity are taxed as ordinary income.  Note that many differences exist between CDs and fixed annuities such as the FDIC insurance which applies to CDs but not to annuities or bonds, the fact that annuities may have surrender charges or expenses associated with them, while CDs may have early withdrawal penalties, and the fact that the term of annuities often exceeds the terms of CDs. While CDs are FDIC-insured, annuities are guaranteed by the claims-paying ability of the insurance company. Additionally, the purchase of annuities may incur commission, and annuities may not be as liquid as CDs. Annuities, once annuitized, cannot be surrendered for value.  Risks of this laddered annuity strategy are the fluctuation in rates that may exist when time to annuitize the other annuities, and the fact that there is no principal remaining if all annuities are annuitized.

CD Bank rate – gives 3.25% for $100,000 as highest 5year CD from Discover Bank, DE 12/30/09. gives this as average payout for 16 companies for 70 year old male in Florida for $20,000 premium 12/30/09.

[1] CD Bank rate – gives 3.25% for $100,000 as highest 5year CD from Discover Bank, DE 12/30/09.

[2] gives this as average payout for 16 companies for 70 year old male in Florida for $20,000 premium 12/30/09.

[3] United Heritage Life, Secure Value 5, five year guaranteed rate 3.75% as of 12/30/09.

[4] Based also on  current average payouts for 16 companies for 75, 80, 85, and 90 year old male for the respective premium amounts 12/30/09.