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How Do Interest Rates Affect Annuities

Interest Rates | How Do They Affect Annuities

Everybody is asking me this, how do interest rates affect annuities? Now, you just can't say they affect all annuities the same way because there are different types of annuities. What we're going to do is we're going to go through every single type that's out there, and I'm going to tell you precisely how interest rates affect each one of them. 

We have a ton to cover today. I'm going to go over the primary types of annuities out there that we're going to talk about how rates affect them. We will discuss the introductory interest rate that you need to follow and go one by one with each annuity type and tell you how interest rates and volatility affect each one. Also, I'm going to talk about, can you even time interest rates, is there a way to do that, and then interest rates strategies using these annuities that work.

Now people always ask me, hey, Stan, can you time rates? No. You can't.

Let's talk about the primary annuity types that are out there. You have single premium immediate annuities, which solve for income. You have deferred income annuities that solve for income later; you have qualified longevity annuity contracts used inside your IRA that solve for income later. You have income riders that solve for income later that can be attached to policies, and then you have principal protection type products like multi-year guarantee annuities and fixed indexed annuities, and you also have variable annuities. 

We will go through all of those and tell you how interest rates affect each one. People always ask me, Stan, The Annuity Man, what's the rate that I need to follow all the interest rates, what's the bogey, what's the one I need to point to that the industry points to? It is the United States 10-year treasury note, and if you follow that, that's the barometer and what the industry is looking at to price the products.

Now, each product type is affected differently by interest rate movements. The 10-year treasury is the bogey, so you know that. But it affects each type of annuity differently. Sometimes it's a primary factor; sometimes, it's a secondary factor. We will go through each type and tell you if it's primary or secondary and how to follow it. Let's go through each annuity type, and I'll tell you if the interest rate movements are a primary or secondary influence on that product type.

Single premium immediate annuities, the primary pricing mechanism of a single premium immediate annuity is your life expectancy at the time you make the payment. Remember, all the annuity lifetime income payments are a combination of return of principal plus interest. But the primary pricing mechanism is your life expectancy, secondary interest rates. With an immediate annuity, single premium immediate annuities, the interest rates are secondary from the standpoint of a pricing mechanism: number 2, deferred income annuities.

It's the cousin of the single premium immediate annuity. In other words, it's the same structure; you just defer it differently. A deferred income annuity, the introductory pricing mechanism, once again, is life expectancy at the time you make the payment. Interest rates play a secondary role. Following product, qualified longevity annuity contracts. It's a deferred income annuity inside your IRA; once again, life expectancy drives the train on the pricing, interest rates play a secondary role. The next part is multi-year guarantee annuities, which is the annuity industry version of a CD.

Interest rates play a 100 percent role there. That's not a lifetime income product, that's a principle protection product, so it plays a 100 percent role in the pricing of multi-year guarantee annuities. The fixed indexed annuity, it's a little different because interest rates play a significant role because the options that the companies are buying it's influenced by interest rates, so I would say it's a semi-primary pricing mechanism, but if you attach a lifetime income benefit ride or two in an indexed annuity, then life expectancy drives that pricing train.

It's a little different, but with fixed indexed annuities, the interest rates can be primary, a little bit secondary, but if you attach an income rider, then it’s life expectancy. Then lastly, variable annuities, which are a market product. In essence, it's the way you look at your investment stocks and bonds and those types of things, ETFs, with interest rate movements. The same happens with variable annuities.

A variable annuity is a market growth product, so typically, that's good for the stock market when interest rates go down. In most cases, that would be good for variable annuities. Still, the interest rate component doesn't affect variable annuities like fixed annuities like immediate annuities, deferred income annuities, qualified longevity annuity contracts, indexed annuities, and multi-year guarantees annuities. Variable annuities it's a little bit of an outlier because that's a market growth product.

Now people always ask me, hey, Stan, can you time rates? No. You can't. Long story short, don't try to time rates because most people are wrong about that. I heard a story the day a guy said, "Well, I think I'm going to wait to buy my single premium immediate annuity until rates go up." First, I told him that rates or secondary pricing factors are life expectancy. If you waited to time rates, you'd have to factor in the payments that you would've missed with a single premium immediate annuity if you bought it right now. Long story short, it's impossible to time rates.

I always tell people that if the contractual guarantee fits their specific situation, it will fit in your plan and just put it in. You can't time it. As we all know, the bell does ring at the top or the bottom, and the same goes for interest rates. Always remember this, when you're buying an annuity type for lifetime income, single premium immediate annuity, deferred income annuity, qualified longevity annuity contract, income rider attachment, the primary pricing mechanism is life expectancy; it’s not interest rates.

If interest rates drastically move, would it move the needle a little bit? Of course, it would. But you have to understand that life expectancy drives the train. The annuity companies have significant buildings and life insurance companies because they know when we're going to die. It's a guaranteed issue product, and they're grouping everyone in your age group, and they're saying some of you are going to live longer, some of you are going to live shorter, and so they price it to your life expectancy. Do interest rates play a role? Yes, of course, it plays a role because all income comes from the new ways of a combination of return of principal plus interest. Still, life expectancy is the primary pricing mechanism for lifetime income guarantees. 

What are the income strategies that work out there? Nothing works perfectly. As I always say, there are no good answers, just bad sales pitches. Everything has limitations and benefits, but let's talk about some strategies that might help a little bit with interest rates and you being at a point where you feel comfortable that you're taking advantage of either the possible movement of interest rates, etc. Let's talk about principal protection. One of the things I like to do is ladder multi-year guarantee annuities.

In other words, if someone said they have $300,000 and they’re not sure where rates are going to go, then what we'll do is we'll buy 100,000 in a three-year duration, 100,000 in a four-year duration, and 100,000 in a five-year duration. That's called a fixed rate ladder. I also do what's called a mixed fixed ladder, which is a combination of multi-year guarantee annuities and fixed indexed annuities. The multi-year guarantee annuities guarantee a specific percentage. The fixed indexed annuities don't, but they can perform a little bit higher than CD, so that we might do a three-year, a four-year, and a five-year multi-year guarantee annuity.

And then, at the seven-year level, we'll do a fixed indexed annuity. That's like a mixed fixed ladder. We also can ladder for income. If someone says, I don't know where interest rates will go, and I feel later they're low, but I still need income, and I've got $300,000. I'm just using that just for easy math. What we do is we say, let's buy $100,000 immediate annuity today, let's buy $100,000 immediate annuity this time next year, and then $100,000 immediate annuity in year three. What are you doing? You're not timing rates, you're almost dollar-cost averaging in, and I guess that's just another way to combat interest rates. There are no perfect answers.

Never forget to live in reality, not the dream, with annuities and contractual guarantees! You can use our calculators, get all six of my books for free, and most importantly book a call with me so we can discuss what works best for your specific situation.


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