Income Strategies When Rates Are Low
A lot of people need income right now. They can’t wait. Talk about bad timing!
The days of living off your interest by buying CDs and AAA bonds are long gone and might not return for a while. As of this writing, the ten-year Treasury is hovering at 1.50% with the possibility of that rate going even lower.
I wasn’t alive when Eisenhower was in office and interest rates were at these current low levels, but I think I might have seen him recently on CNBC as a guest expert!
Regardless of current interest rates, you still have to plan for your lifetime income needs. Compared to other income strategies, annuities are the best “transfer of risk” strategy going.
So what do you do if you are planning for income using annuities? Well, there are only two ways: income now or income later. Let’s look at both strategies and how to do “transfer of risk” income planning in a low-interest environment.
When you need income now using annuities, you are primarily talking about Income Annuities or Single Premium Immediate Annuities (SPIAs). This is the original annuity structure that most people are familiar with. It is the purest form of income “transfer of risk” annuity strategy.
Lifetime income payments from SPIAs are based on your life expectancy and are a combination of a return of principal and interest. There is no way to calculate a real ROI (return on investment) until you die!
The problem now with SPIAs is obviously the interest portion of the payment. The benchmark interest rate for SPIA calculations is the ten-year Treasury, which is now at historic lows. In essence, SPIAs are the purest reflection of current interest rates, so you have to be conscious of locking in at these levels.
Here are three strategies that I am using with my clients to combat these low rates:
· Add a contractual COLA (Cost of Living Adjustment) Rider to the SPIA contract so that the lifetime income stream will increase by that contractual percentage annually. For example, I just placed a SPIA with a 6.5% COLA for a client, which means that the income stream will increase every year by 6.5%.
· Some newly designed SPIAs now offer a “future lock in” feature if interest rates rise down the road. For example, there is one carrier offering that if you purchase a SPIA today and in five years rates have risen, they will then lock your lifetime income payment at that higher rate.
· Ladder your SPIAs by purchasing them on an annual basis in order to “stack” your lifetime income stream. For example, I had a client recently call and say that he wanted to put $300,000 into a SPIA. After further discussion and running the numbers, my recommendation to him was to place $100,000 each year for three consecutive years in order to get a higher payout and hopefully lock in higher rates in coming years. Even if rates do not move, the payout will be higher because the client will be older.
When you are planning on taking income down the road, my recommendation is to attach an Income Rider (attached benefit to an annuity policy) that will contractually grow by an annual percentage during the deferral years. I call this “target date” income planning.
Income Riders should be attached to fixed annuities, not variable annuities, because the cost is lower and the actuarial percentage that is paid when you turn on income is normally higher.
Income Riders grow and compound annually by the contractual amount and can be used only for future income. Once the lifetime income stream is turned on, then that contractual growth stops. Agents have a “tendency” to incorrectly sell or imply that these riders are yield. Income Riders are not yield!
Income Riders are currently offered at 5%, 6%, 7%, or 8% annually during the deferral years. Remember, you can only access this amount for a lifetime income stream, thus this is a good way to plan for income in the future.
Obviously, these higher % numbers are larger than current interest rates…because they are not interest rates!
Income Rider totals are “monopoly money” unless used for income. Remember, that you buy annuities for what they will do (contractual guarantees), not what they might do (hypotheticals). Below are three strategies I use for “Income Later.”
· Use an Income Rider to calculate to the penny what your income stream will be in future years. Be sure to look at the Rider percentage rate along with the actuarial payout rate. The highest rider rate might not have the highest payout. For example, a 5% annual rider might have a higher payout than a 7% annual rider because the back end actuarial payout percentage is higher.
· Consider the newer Income Riders that grow by a specific annual percentage during the deferral years, and then increase your income annually to combat inflation once you turn on the lifetime income stream. For example, there are Income Riders now available that grow and compound by 6.5% annually during the deferral years, and then when you turn on your lifetime income stream increase that income stream annually with CPI-U increases, similar to how Social Security works.
· Ladder Income Riders by spreading out your “target date” strategy over a few years. If rates do happen to rise, then there is a possibility of the Income Rider annual percentage being higher. For example, four or five years ago some Income Rider contractual percentages were as high as 10% to 12% annually. We probably won’t see those kind of rates anytime soon. However, if you spread out your target date annuity plan, you might benefit from higher Income Rider percentages.
Annuities, like most investment products, are affected by interest rates. For immediate income needs, current rates have a bigger influence than if you need income later. Regardless if you need income now or later, AND regardless of where rates are now or where rates will be in the future, you need to plan now for your lifetime income needs.