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I RETIRED ALMOST TWO years ago, at age 56. My wife, who is nine years younger, decided to semi-retire so we could relocate from Rhode Island to Florida. We were able to afford early retirement in part because we’d lived below our means for many years, diligently saving while also paying off our mortgage and other debts.
Relocating to a state with a lower cost of living and lower taxes also helped. In addition, I’m fortunate to get a modest pension and relatively affordable retiree health insurance coverage for both of us.
So, yes, we’re lucky—and grateful. The trouble is the date I retired: Dec. 31, 2021. It was days before the onset of a bear market that tanked our stock index funds, and only months before steep interest rate hikes sent our bond index fund tumbling, too. All in the face of rising inflation. Talk about bad timing.
Despite it all, I’m calm and confident about our retirement. Why? First, we’ve been living easily within our projected monthly budget. We draw down about 3.5% of our total nest egg each year, adjusted annually for inflation.
Second, we have a relatively aggressive mix of 70% stocks and 30% in bonds and cash. This high stock exposure gives me confidence that we’ll stay ahead of inflation over time.
I’m not worried that this mix is too aggressive for a retiree like me because it contains enough cash reserves to live on for four or five years. If necessary, selling bonds could then see us through an additional three or four years.
Unfortunately, we pay a price for this peace of mind. Our cash is likely to lose ground to inflation in the coming decades. We have an online savings account that pays a higher interest rate, but in recent years the returns haven’t come close to keeping up with inflation.
One popular strategy to squeeze out even higher yields from cash is to ladder CDs, or certificates of deposit. This might mean depositing a year of expenses in an online savings account, while also buying CDs in the same amount for terms of two, three, four and five years. By replacing each of these at maturity with a new five-year CD, you soon end up with a maturing five-year CD every year.
Laddering CDs strikes me as a safe strategy to lessen the bite of inflation. But they aren’t the only option for a laddering strategy. I’ve decided to stash most of our cash reserves in a multi-year guaranteed annuity ladder.
Multi-year guaranteed annuities are the life insurance industry’s answer to CDs. As the name implies, they’re fixed-term annuity contracts that pay a guaranteed annual rate of return on a lump-sum premium for a specified term. Despite mimicking CDs, however, they have important differences.
Typically, multi-year annuities pay about one percentage point above CD rates. As of this writing, the highest annual yield that I could find for a five-year CD was 4.9%. I can find a multi-year annuity paying 6% with a $20,000 premium.
Almost as important as the higher yields are annuities’ tax-deferred compounding. While interest earned on CDs is taxable annually, annuity yields are taxable only when you cash out.
Better still, when these annuities mature, they can be rolled over tax-free in a 1035 exchange. The exchange doesn’t need to be with the same company, so you can roll them over to the best rate available. In theory, these yields could compound indefinitely until you opt to cash out.
There are drawbacks to annuities, too. One is that they come with less solid government protection against default. Most CDs, as the product of a bank or credit union, are protected by federal deposit insurance up to $250,000. In the case of most annuities, the protection is provided by the state-sponsored insurance guaranty association.
Although the amount of protection promised in most states is the same as the federal protection for bank products, state-level protection doesn’t rise to the same level of surety as federal guarantees. This additional risk is real, but to me it seems manageable. By design, each of the five annuities in my ladder is from a different company, thus spreading the risk. None of the companies has ratings below B+, and most have A or A- ratings for financial strength.
A second drawback is that annuities require more time and effort to purchase than CDs. It’s essential to work with a good insurance agent with annuity expertise. Even the best agent can’t eliminate what’s inherently a painful process, however.
Each annuity requires reviewing a complex annuity contract, and then completing a lengthy and intrusive application process. Each contract can vary significantly on key features such as early withdrawal allowances. Although most companies have user-friendly online applications, others still do everything by paper and mail. All in all, expect it to take weeks or longer to get final approval.
Both CDs and annuities have early withdrawal penalties, but there are differences here, too. Unlike CDs, which by law must impose early withdrawal penalties, some annuity contracts allow for interest earned, or a percentage of the initial premium, to be withdrawn yearly without penalty. Others don’t, however, and can impose steep penalties, especially in the early years.
What about the commission paid to the agent I use, as well as an annuity’s other expenses? I don’t need to worry about those costs because—as with a CD—the yields that are quoted already reflect all expenses.
Like all annuities, mine are subject to a 10% federal tax penalty on any interest earned if I cash out before age 59½. If I died prematurely, my spouse would incur this penalty unless she kept rolling over the annuities until she reached 59½. These annuities may not be a good option for anyone who’s a lot younger than 59½.
So, is annuity laddering a good alternative to CD laddering? For me, the answer is yes. That extra one percentage point in interest may not sound like much. But thanks to tax-deferred compounding, it could make a big difference over many years. That said, I imagine there will come a time when my wish for financial simplicity will outweigh my desire to squeeze out a little extra interest.
David Cooper worked for many years as a career policy official in the Office of the Secretary of Defense. He subsequently became a professor of national security affairs. David had no particular interest in personal finance until it dawned on him in his late 40s that he had no idea how or when he could retire. He’s grateful for the many insights he’s gleaned as an avid HumbleDollar reader.
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Thanks for the article. I had never even considered multi-year annuities.
Our situations are very similar. I am retired Department of the Army civilian with a modest pension (FERS) and health insurance. I retired on the same exact date as you (12/31/2021) and was confronted with a similar sequence of return risk.
Luckily I had set-up my own business as a licensed professional engineer before I retired. I have been blessed with some pretty decent consulting work as well as outside projects through the business, so I am “semi-retired”.
I have not had to withdraw any tax-deferred savings yet, and have even been able to make a few small Roth conversions while paying the taxes with money from outside those accounts. I looked at making the Roth conversions in 2022 and early 2023 as “making lemonade”.
I have some cash set aside that I would need when my business income decreases in a CD ladder, but I will definitely consider the annuity option going forward.
In the meantime I am just very thankful for the Lord’s provision of this part-time work that is providing income and a gentle transition into full retirement while postponing claiming SS and IRA withdrawals.
Thanks for sharing. Very nice insight.
Ouch!
Sequence of Return risk hit you hard.
We were plain lucky enough to retire in 2015 (me) and early 2018 (my wife).
Pure dumb luck.
Most states regulate insurance companies that sell products (life, property, liability, health, LTC, and annuities) in their states. It’s common practice that states set up guaranty associations and every insurance company doing business in that state pays a percentage of sales into the guaranty fund should an insurance company become insolvent and be unable to fulfill its obligations. Some states do these guaranty associations better than other states. In my state of Georgia, there is a total of $300,000 worth of coverage for all contracts for each Georgia citizen. The guaranty association will take ownership of the insurance contract and fulfill the terms of the contract to the specified state limit. Like FDIC, there’s a limit to what you can receive. https://www.annuity.org/annuities/regulations/
I don’t want to fight with a legion of annuity brokers–in fact, I once was one, if that counts for anything. All the same, I think it might help to peel back the curtain a bit. The annuity is offered by a company. That company invests its money in the same markets we do, although at a much bigger level. So an annuity is really investing in the markets but at a greater distance. The guarantees we get are being purchased indirectly from the same financial markets. The company selling the annuity had better make a profit to do so as well as paying all the people who manage the complex contracts and transactions.
So before I buy an annuity, I would always ask why do I need to pay for all that? I would suggest I don’t and neither does the author. If I can ladder annuities, I can also just invest my money directly and manage the risk.
Still, this is a great article about how one type of annuity strategy works. And no company would market such a product unless there were real people who found it attractive enough to buy.
If I’m interested in how insurance companies (annuities are an insurance product) invest their money, every publicly traded insurance company provides that information in its annual reports. I find it interesting reading. Of course, Warren Buffett’s Berkshire Hathaway is one of the most famous such investors of insurance reserves, but there are many others.
BTW, when I was shopping for annuity products in my 50s, I discovered that while Berkshire Hathaway offered some good rates, the best rates I found were available through Schwab’s partnership with an insurance company, so if you use a discount broker, consider asking your broker if they have such a partnership to offer such products as well. I suspect the reason the rates were better was probably because their sales expenses were lower. Why was I shopping for annuity products? I had not put enough aside for retirement and I had kids who would be going to college soon. Retirement assets, including annuities, are generally not included in the calculations of how much parents can afford to pay for their kids in college.
Interesting article. I would question whether a 3.5% withdrawal rate, adjusted for inflation, is appropriate for a couple 56 and 47 years old. The 4% rule assumed a 65 year old couple, and many financial experts feel that 4% could be too agressive based on forward looking return assumptions today. However, as a (now retired) financial planner, I have always questioned applying the 4% (or any fixed percentage) rule for a withdrawal rate. The success or failure of a fixed rate withdrawal strategy depends largely on the market conditions shortly before and after the actual retirement date (this is called sequence risk). Many of those who retired after a prolonged bull market and shortly before a significant and prolonged market decline faired poorly with a 4% withdrawal rate, while those who retired immediately after a market decline (your case) almost always did well.
I used to sell annuities. The fixed ones aren’t as onerous as the variable annuities, but as you point out, there an re a lot of restrictions. Also, most nice places to live in Florida are no longer cheaper than northern cities. Miami and Tampa and surrounding areas are two of the most expensive in the nation, and the other big cities are right behind. The cheaper places are ones that most would not want to live in. Also, while there is no income tax, they make it up elsewhere with local taxes. Governments need money to function. I lived in Florida for over 20 years, and their property taxes are high, their home insurance rates have skyrocketed, and their auto insurance is extremely costly. My insurance agent said that is because of so many under or non-insured drivers in the state. Also, the weather from May to October is brutally hot and humid, which is why the snow birds fly north during those periods. Summers in Florida are as bad as winters in the north. Also, the cockroaches and fire ants are no fun.
I can only speak to my own personal experience, but after two years living here in Florida, I am very confident in saying that our net cost of living is lower than it was in Rhode Island. Not having any state income tax is huge, especially since Rhode Island income tax rates were very high. Our sales tax here is roughly the same. Our real estate taxes are actually slightly lower (and under the state’s homestead rule for primary residences these will not rise by more than 3% per year regardless of rising real estate values). Food, fuel, and utilities are all lower. The big exception is that our home and auto insurance are higher, but in our case at least, not dramatically, and certainly not enough to offset the above savings. However, for anyone with a poor driving record or a high-risk home (flood zone, old roof, etc.) I can imagine that the higher insurance factor might easily offset the others. Fingers crossed that isn’t us in the future!!
Also, Medigap insurance plans cost a whole lot more than here in North Carolina.
We have our Medigap through AARP (United HealthCare). My logic may be faulty, but AARP has more clout with United than I will ever have and should be able to wrangle the best deal. Here’s where my logic comes from. Years ago, Hartford quit writing coastal insurance in Florida for everyone except their AARP customers. AARP had that much clout through the national AARP program with Hartford that they could get them to do that. Individual customers through Hartford could not. That’s probably not the case today but the logic still lingers for me.
I pay $271 a month in NJ for plan G
An AARP/UH Plan G, which I can get for $151/month in NC, at age 76, would cost me $342/month in Boca Raton.
$271? That’s outrageous. I just signed up for a BC/BS G plan at 66 in NH and it’s only $171
BC/BS seems to be among the most expensive issuers. I suspect it’s because they pay a higher commission to agents, as it was the first plan I was offered when calling one. Fortunately I had already checked prices on medicare.gov.
I obtained the coverage directly through Medicare.gov, ie not thru an agent. BC/BS was only about $10 more than another insurer that I had the displeasure of dealing with when taking care of my disabled brother so they were not even considered.
We all pay the agents’ commissions, they are baked into the price, not charged to the individual purchaser. The cheapest Plan G I could get in NC was about $100 cheaper than BC/BS.
Why is this down-rated? Are you disputing my facts? You can go to medicare.gov and check them yourself.
A partial alternative or supplement to an annuity ladder, for those who are able, is I-bonds which if bought before the end of April 2024 are paying a guaranteed fixed rate of 1.3% over inflation for the 30-year life of the I-bond. They can’t be cashed in the first year, and there’s a 3-month interest penalty if cashed before 5 years, but after that there is no downside to cashing them at any time. The interest compounds tax-deferred and is state tax free (not an advantage in states without an income tax, like Florida). Administratively the only hassle is up front, establishing the TreasuryDirect.gov account; once purchased you can forget about it until you cash it. Individuals can only purchase a maximum of $10,000 each calendar year (plus another $5,000 can be bought with a federal tax refund), but one can buy the maximum this month and then again in 2024. A living trust can also buy one each year, as can any businesses you own that have a separate bank account. A website I recommend for information about I-bonds (and TIPS) is tipswatch.com
Unfortunately, when you cash the annuity in, you realize all income in a single year and it could push you into a higher tax bracket and a higher IRMMA Medicare premium.
Thanks Buz, I appreciate the comment. Yes, that is the double-edge sword of not paying interest every year like with a CD, but rather only when you cash in. For us, this is desirable because we are using these MYGAs to backstop needing to sell stocks in down years. Thus, paying taxes on the MYGA interest when we cash it out should be more than offset by not having to paying taxes on selling stocks (especially stocks from our traditional retirement accounts that are taxed as regular income). A question for you: would paying annual taxes on the interest on several CDs be that much less of a tax hit than paying several years worth of interest earned on a single maturing MYGA? It seems like those would balance out in the wash?
Setting up an annuity ladder need not be complicated. Sites like Blueprint Income and Stan the Annuity Man offer quick and easy instant online quotes showing you what options/rates are available for different terms, and clear explanations of how the product works.
I don’t recall any rules about age-limited withdrawals, but maybe there are some.
One difference I noted when I was looking at these was that interest doesn’t compound while the annuity is maturing – it only is paid out as a straight calculation at the end of the annuity term. This makes their APRs slightly less attractive than the quotes rates first make them sound.
“Each annuity requires reviewing a complex annuity contract, and then completing a lengthy and intrusive application process.” Was there a life insurance component in those annuities? Most life only annuities have easier applications. They company doesn’t want you to hang around, as opposed to a life insurance contract where they hope you live forever.
Very thoughtful article. It’s well thought out. I appreciate you sharing your plan like this.
The OP lives in Florida, and believe it or not, Florida has strict suitability requirements for all annuity contracts.
David purchased not life-only immediate annuities, but rather five-year tax-deferred fixed annuities.
Interesting. I quit working in 2020 (at age 67) and stashed enough cash in laddered T-bills to see us through the end of 2024. I took SS at 70 and now our SS covers 70% of our annual spending. Starting in 2025, I will need to start liquidating $30-40K a year to cover expenses and am creating a strategy to do so.
I don’t need to take RMDs until 2026 BUT my current thinking is to start taking dividends on my IRA dividend fund ($12K) rather than reinvesting them and take the remainder from my Schwab Intelligent Investment portfolio. I have a small Roth which holds some speculative stocks (EVTOLs, quantum computing and batteries!) if any of them surge, I’ll take some profits.
Living on cash was easy—now I’ve got to be more strategic!
You had me intrigued on the annuities until you got to the part about how complicated and time-consuming they are. I think maybe when you’re as young as you and your wife are, such issues may not feel as daunting. I’m 63 and still working, but I’m already thinking ahead to simplifying our finances to account for age-related cognitive decline.
IMO, you’re plenty young to benefit from a deferred annuity. You could consider a Fixed Indexed Annuity with a term of 5-7-9-years and just let it grow tax-deferred. You could add an income rider for guaranteed income. The application can be a bit complicated – but that’s for the agent to handle, and once you’ve provided all the required information – you’ll sign the paperwork and you’re done.
Hi and thanks. Per my response to mytimetotravel, these are more complicated than CDs, but it really isn’t too bad.
Welcome to retirement and congratulations on living below your means. As I keep saying, it’s key to retiring early. Interesting article, but at 76 I’m more interested in reducing complexity than increasing it, and this sounds complex.
Thanks for the retirement welcome! I didn’t want to sugarcoat things, but at the same time I also hope that I didn’t make this sound more complex than it really is. There is no question that using a MYGA ladder is more complicated than for CDs, but it really isn’t too bad. I probably spent 15 hours setting up the initial ladder of five MYGAs. This took a bit longer than might otherwise have been the case because I was unfamiliar with the process and carefully reviewed and asked question about each contract. I just did my annual 1035 exchange–rolling over the initial 3-year MYGA in the ladder to a 5-year MYGA with a different company– and the entire process took about two hours. My agent discussed options and then sent me the new contract to review (which didn’t take as long now that I know what I am looking for) and walked me through the online application (including a state-required financial suitability questionnaire). So more complicated than CDs, but a couple of hours every year isn’t terrible if this makes financial sense for your situation.
I am fascinated by living below your means. To me that means always saving, never carrying consumer debt. I guess the variable is the saving part and that ones “means” comes after saving, but there could be a wide range – saving 10% or say 30%. One gets a good accumulation, the other not so much.
If by “consumer debt” you mean credit card debt, I have always paid my cards off each month. If you mean a mortgage or car loan, yes, I’ve had those. Really, it’s very simple. You spend less than the amount deposited in your bank account (after taxes and 401K deductions etc.) and at the end of the month the excess goes to taxable savings.
I look back at all the “phases” of my life and I realize I’m still going through phases. Like you I appreciate less complexity.
Your article raises many questions for me, but I know if I ask them I will be in trouble.
However, I’m going to try one. Your drawdown strategy is designed for 30 years. You are 58 and your wife 49 and you have already been retired two.
Are you comfortable that all you have planned financially will be adequate for two lifetimes over forty years or so?,
Thanks for your question! I should have clarified that the 3.5% drawdown rate is only until we start claiming social security, after which it will go down. So yes, I am confident this is sustainable.
Please ask the rest of your questions. This is a learning forum after all, and that first question is spot on.
Thanks for this timely article. I have also studied this subject and have a 3 rung ladder being completed with a 1035 from a fixed indexed annuity that has matured out of the penalty phase. It returned about 2.7% a year for 10 years and turned out to be an expensive product. I have now locked in 6% in the ladder with companies that are A or above. These MYGAs are spread between 3 companies and also allow interest to be taken each year. For those of us that can live on interest only, these make sense.
Very good explanation of MYGAS. Personally I like everything under one roof for simplicity.
Thanks for the positive feedback. Yes, MYGAs have many virtues under the right circumstances, but simplicity isn’t one of them!