How to time annuity purchases
The number one question I receive concerning a potential annuity purchase revolves around current interest rates.
The last few years have proven that rates do not “have to” go up, and that Jimmy Carter-type yield seems like a distant dream.
The reality of timing the purchase of an annuity is it’s impossible, just like you cannot perfectly time anything in the financial industry. Now that you know the answer to the question, you need to also know the common sense solutions to this ongoing rate issue concerning annuities.
The reality of current rates
If you look at the 10-year Treasury equivalent rates across the globe, the ugly reality is that the U.S. rate is high when compared to Japan, Great Britain, Germany, France, and Spain. There is no tick data on what happens when countries print and buy back their own money, even though this unknown blue water strategy was given a seemingly calm name: “Easing.” I think “drilling” or “hammering” would have been a more appropriate moniker, but that’s why I’m not in politics.
Killing time without getting killed
Timing interest rates with your annuity purchase is like trying to nail Jell-O to a wall. The vast majority of people that contact me believe that interest rates will eventually be higher, but usually are smart enough to not try to guess when.
For those financial savants, I recommend laddering short term fixed-rate annuity paper. Just like you ladder CDs and bonds, you can also ladder annuities with durations as short as three years. My advice is to not go past five years, so you can have money coming due with hopeful rising rates.
Call it “killing time” or call it “treading water,” but this is an efficient strategy to keep your powder dry for another day while protecting the principal, deferring taxes, and receiving a contractual yield.
Ladder the purchase date
For lifetime income annuity purchases, the only timing choice you have is laddering the purchase date. Because annuity income streams are primarily based on your life expectancy, the older you are when you start the payments the higher the guarantee. If you are so fortunate to have rates move in your favor, then the income stream will be even higher.
A prototypical example of laddering income would involve purchasing a single premium immediate annuity (SPIA) every year over a period of time. A $500,000 allocation would be purchased in $100,000 tranches over a five-year period.
The cost of waiting
It’s important to point out that annuity income streams are a combination of return of principal and interest. It’s a life expectancy bet between you and the annuity company, and they are on the hook to pay regardless of how long you live. That’s the true value proposition of a lifetime income annuity.
With that being said, if you need income now but feel hesitant because of interest rates, you need to calculate the cost of postponing the purchase. The factual reality is that rates would have to significantly move in order to legitimately justify the delay of turning on the income stream right now.
Disclosure for ‘hybrid’ dream catchers
Some of the dumbest and most tragic calls I get come from victims who think they just purchased a 7% or 8% annuity. Trust me that there is not some genius at an annuity company that has figured out how to turn a 10-year Treasury at 2% into an 8% yield.
What those “dreamers” own is an income rider that is typically attached to an indexed annuity, which many agents incorrectly refer to as “hybrids.” With income riders, you can’t peel off the interest, get to it in a lump sum, or transfer that amount. You can only use that high percentage growth amount for income. Sorry to burst that agent sales-pitch bubble.
Annuity haters unite
Just to beat all of you uninformed annuity “broad brusher’s” and “knee jerker’s” to the punch, if you can manage your own money and risk — then you don’t need an annuity. Not everyone needs an annuity.
However, if you include yourself in the vast majority that need specific contractual guarantees and want to transfer some risk, then understanding the interest rate annuity puzzle is very important. Be smart enough to know that you cannot accurately predict interest rates, and as I always advise people, trust your gut feel on comfort level when implementing any annuity strategy.
The bottom line is that transferring risk using an annuity is not an investment decision, it’s a lifestyle decision.
Originally published 3.31.15 by MarketWatch.com – http://www.marketwatch.com/story/how-to-time-annuity-purchases-2015-03-31