The interest-rate struggle with annuities

We are all waiting for interest rates to start going up, and no one watches the 10-year Treasury more than the annuity industry. It’s common sense that if rates go up, then annuity pricing will improve, but as with most choices in life, the decision on the perfect time to implement an annuity strategy is not that simple.

Rates “have to” go up?

I have heard this statement many times in the last few years, and every single person has been wrong. Rates don’t “have to” go up. If you look at the MarketWatch list of 10-year Treasury equivalent rates across the globe, our U.S. 10-Year is still the highest. Most people don’t realize that other countries like Germany, Japan, U.K, Italy, and Spain all have significantly lower 10-year rates.

Historically, rates don’t move much going into a presidential election cycle. In addition, raising rates will just increase the government’s interest payments on the debt, so there’s no rush for them to take action.

Immediate annuities

Single Premium Immediate Annuities (SPIAs) are a combination of return of principal and interest. If rates go up, then lifetime payouts will be higher. However, in addition to interest rates, another risk to consider is the possibility of life expectancy tables changing against you.

Longevity annuities

These are also referred to as Deferred-Income Annuities (DIAs), and another version of this annuity type is called a Qualified Longevity Annuity Contract (QLACs). This is also an “annuitized” product like an SPIA, so the income stream is a combination of return of principal and interest. Once again, life-expectancy changes could affect payments just like interest rates.

Fixed-rate annuities

Similar in function to CDs, these are also called Multi-Year Guarantee Annuities (MYGAs). When rates move, we all know that CD yield moves as well. The same can be said for MYGAs, but these fixed-rate annuities typically guarantee slightly higher yields than comparative CD offerings.

Indexed annuities

These are also called Fixed-Index Annuities (FIAs), and are basically fixed annuities with index call option strategies that historically provide a little better than CD returns. When rates move up, the index crediting strategies can provide better potential returns. However, there is no “market upside with no downside” with indexed annuities. The only true component of that typical sales pitch statement is the “no downside” part.

Income riders

These contractual guarantees can be attached at the time of application, and are separate calculations that can only be used for income. In the current low-interest-rate environment, this is where the sales games are played.

Income rider percentages are typically high, but are not yield. You can’t peel off the interest or get the lump sum. If not used for income, it’s a phantom account and goes “poof” when you die.

Variable annuities

The attached benefit income riders to variable annuities are most affected by interest-rate movements. The mutual funds inside of a variable annuity (AKA: separate accounts) are market instruments, so they are what they are.

If interest rates move up, then the income-rider pricing would be better. However, in most cases, income rider guarantees attached to fixed annuities outperform those attached to variable annuities by design.

The nonsense of timing rates

Please tell me that you are smarter than to try to time rates, especially when it comes to annuities. For example, if you needed to lock in an annuity lifetime income stream now and delay the purchase to try to lock in a higher rate, you would have to factor in the lost payments while you wait vs. the potential increased payment. What would be the breakeven point, and how many years would it take to actually make up for your supposed “timing” strategy?

“Yellen” for higher rates

Whether you like her or not, Janet Yellen inherited one hot mess of an economic situation. Baby boomers and retirees have been “Yellen” for rates to go up … so to speak. For people who yearn for guaranteed rates, these past few years have been some tough times for the savers, principal protectors, and those who need the best lifetime income guaranteed payouts.

Like you, I hope that rates will go up … but I’m not holding my breath.

Originally published 7.28.15 by MarketWatch.com