How to Build My Own Annuity

An annuity is a ladder of investment maturities.
i Hemera Technologies/ Images

An annuity is a well-planned investment portfolio created by an insurance company, so it is possible for anyone with the time, knowledge and perseverance to build something similar. Insurance companies buy investments at institutional rates that are less expensive than you can access, because they normally buy hundreds of millions of dollars worth of securities every day. However, you can create a portfolio to provide dependable income, for as long as you manage it properly. The key is constant objective management.

Step 1

Open a self-directed tax-sheltered investment account such as an IRA or 401K at your local bank or securities broker. This will allow you to collect interest and profits in the account without having to pay income taxes and compound your investment income. Because laws affecting such accounts change, consult a professional financial adviser where you open your account to determine the best choice for your intended purpose. Ask whether to put dividend-paying stocks in a separate taxable account. Many advisers suggest building a portfolio of dividend-paying stocks in a taxable account because dividends are taxed at a lower rate than ordinary income. However, the tax treatment of dividends can change, so you may want them in a tax-sheltered account, instead. In case you need money for an emergency, choose an account you can borrow against without selling the securities within.

Step 2

Create a realistic estimate of the amount of money you will need your annuity to supply in income. This gives you an idea of how much principal money your annuity will require to return the income stream you desire. It also gives you a goal and incentive to continue to build your annuity over the years.

Step 3

Learn about U.S. Treasury bonds, corporate bonds, certificates of deposit, preferred stock and dividend-paying common stock including utilities and high-quality industrial stocks. These fixed-income securities will form the core of your annuity. Also, learn about bond laddering. An annuity is, basically, a large bond ladder.

Step 4

Ladder your bond investments. When you begin to build your annuity, divide your money into 5 or 10 equal amounts, depending on the size of your first investment. If interest rates are at historically low levels, invest each chunk of money in a certificate of deposit or Treasury bill, depending on which yields more. Maturities should be laddered in year increments. As each security matures, invest it in a longer maturity instrument. During periods of historically average or high interest rates, ladder your maturities out to 30 years and continue filling in missing years as you add more money. Ideally, you will have bonds maturing every year, out to 30 years.

Step 5

Reinvest interest you receive in certificates of deposit or Treasury bills out to one year. Ladder these investments to mature monthly or quarterly. Accumulate your interest income in these short-term investments until you have enough to fill in a missing year in your long-term ladder or spread the money out over a particularly high-yielding section of the yield curve. Some advisers suggest using your interest income to buy dividend-paying stock because its value tends to keep up with inflation.

the nest