5 annuity strategies to combat low interest rates
With the 10-year Treasury hovering around 2%, a common question I continually receive is how to combat these historically low rates when buying annuities.
There’s no perfect answer of course, but there are some common sense strategies that you need to be aware of if you are considering these contractual transfer-of-risk products.
With annuity lifetime-income guarantees, the primary pricing mechanism is your life expectancy at the time you start the payments. Annuity lifetime income streams that are contractually guaranteed are a combination of return of principal and interest. You are, in essence, betting with the issuing carrier that you will live longer than they think you are going to live and they are on the hook to pay if you do.
That’s a simplistic definition of the value proposition of a lifetime income annuity.
Ladder purchase dates
Just like you can ladder CDs and bonds, you can also ladder annuities. With income annuities like single premium immediate annuities (SPIAs), you can split your purchase amount over time to hopefully catch rising rates. For example, a $400,000 SPIA allocation might be implemented in $100,000 increments over a four-year time period.
Ladder income start dates
With products like longevity annuities (aka deferred income annuities) or QLACs, you can start the income streams at different times. This is an efficient way to address future inflation — and remember that the older you are, the higher the guaranteed payment. Using a combination of Longevity Annuities and QLACs, you could structure income streams to start at age 70, 75, 80, and 85. With a $400,000 allocation, you would pinpoint $100,000 for each tranche of guaranteed income.
Ladder both purchase and start dates
For the ultimate income planner and interest rate timer, you could combine both of the above strategies. Using the same $400,000 example, you could purchase a $100,000 annuity for four consecutive years and have the income streams turn on at age 70, 75, 80, and 85.
Ladder yield and surrender charges
Lifetime income isn’t the only contractual guarantee that you can ladder with annuities. Fixed-rate annuities (aka multiyear guarantee annuities, or MYGAs) are the second cousin to CDs because these products offer a guaranteed annual percentage for a specific period. MYGAs are currently offered with as short as three-year surrender-charge time periods. Within a non-IRA account, the interest grows and compounds tax deferred. A current MYGA ladder strategy that I am recommending is purchasing a three-, four- and five-year MYGA to hopefully have money coming due as rates are rising. For example, a $300,000 allocation would place $100,000 in a three-, four- and five-year MYGAs.
Wait for higher rates
I’m sure that many readers were thinking this anyway, so here’s that obvious annuity hater softball. I actually consider waiting for rates to rise before purchasing an annuity a legitimate strategy. I know that the annuity sales gods (and most agents) disagree with this honest and common sense thought, but it does make sense if you feel that rates will dramatically increase in the very near future.
FYI: Income riders aren’t real interest
There is not some genius at an annuity company that has figured out how to give you 6% or 7 % when the 10-year Treasury is less than 2%. That doesn’t prevent some agents from blurring that factual line using rider guarantees. Income riders are phantom accounts that can only be used for future income. You cannot peel off the interest, get to the lump sum, or transfer that amount. This is a common sense fact that too many annuity dream buyers don’t know, but will tragically find out when the contractual realities reveal themselves.
The future is blurry
It’s cavalier to say that interest rates have to go up. I heard that incorrect comment a lot over the past few years. The need for annuity type guarantees will continue to grow regardless of rate levels, so it is very important to consider numerous strategies to fit your specific risk transfer goals. Do your homework with annuities, and make sure to allocate conservatively and buy in proportion.
Originally published 10.22.13 by MarketWatch.com – http://www.marketwatch.com/story/annuity-dreams-and-contractual-realities-2013-10-22