How Do Interest Rates Affect Annuities?
Interest rates affect annuities in sometimes strikingly different ways. The interest rate that most annuity companies follow is the 10-year Treasury rate. When it rises, most types of annuities are better off (but not all of them). When it falls, it often hurts many annuities.
Again, interest rates don’t affect all annuities the same way. So, let’s start by looking at annuity types and then how interest rates impact them. That will help you decide what annuity might be best for your needs.
Basic Annuity Types
Here’s a quick rundown of a few kinds of annuities at a high level:
Single Premium Immediate Annuity (SPIA)
This is also known as an immediate annuity. It’s a fixed annuity in which someone pays a lump-sum premium in return for an immediate stream of payments for a specified period. This period is usually for someone’s remaining lifespan, so it’s a guaranteed lifetime income stream.
With an immediate annuity, your income payments can start from 30 days after the contract is started. The start date for your annuity payments can be as late as 12 months from when your annuity contract was begun.
Multi-Year Guaranteed Annuity (MYGA)
A MYGA is a fixed annuity that offers a guaranteed fixed rate for a specified period, usually three to ten years. The annuity money earns interest per year, and the growth isn’t taxed until you take out money from your annuity.
MYGAs generally have higher interest rates than certificates of deposits offer. Unlike a SPIA, they may accept more than one premium payment.
It’s a good idea to check with the insurance company on whether they will accept additional premiums, if you are shopping around for MYGA rates.
Fixed Index Annuity
A fixed index annuity (FIA) is essentially a fixed annuity with growth potential tied to an underlying benchmark index. How much growth will depend on the movements of this benchmark index.
When the index goes up, the annuity can earn interest based on a portion of that increase. When the index goes down, your money – the original premium and already-credited earnings – is protected from index losses.
The growth potential is limited by caps and participation rates, limiting how much of any upward index movement it can share. This is a trade-off for the protection against losses when the index is down.
Many annuity owners also tap fixed index annuities with income riders for a lifetime income stream. They like the flexibility that the FIA with the income rider provides them.
Ask your financial professional for more information about options for this, if that might appeal to you.
Variable Annuity
A variable annuity is an insurance contract that is also a securities product. It lets you put money into subaccounts that are essentially mutual funds, putting the annuity’s assets at risk in the market.
As a result, variable annuities offer the most growth potential of all annuity types. To be clear, unlike with the fixed index annuity, this does include the risk of your money losing value.
Variable annuities also give you the option for a guaranteed lifetime income stream. Many variable annuities have income rider benefits that you may choose to use.
A Quick Note on the 10-Year Treasury Rate
Ten-year Treasury notes are debt instruments of the United States government. They pay interest at a fixed rate twice a year, and they pay off at face value at maturity.
The rate is the interest that the government must pay to attract bond purchasers. It’s usually significantly lower than most other rates because of the extremely low risk of default.
Inflation, and actions by the Fed to slow inflation down, can have effects on rates, as well.
What Effects Do Interest Rates Have on Annuities?
Treasury rates, and interest rates in general, affect different annuities in various ways.
SPIAs – In general, payments on a SPIA depend on your life expectancy and long-term interest rates. In other words, if rates are higher when you buy your SPIA, you will get a higher rate of return.
Still, life expectancy is the primary driver of payouts. So, it will depend on your life expectancy at the time that you buy an immediate annuity.
Of course, the life insurance companies structure all this stuff. In a higher interest rate environment, they might adjust the life expectancy tables slightly to help maintain their contractual promises to their many policyholders.
Still, in the end, higher long-term rates generally mean higher payments on annuities. That goes for immediate annuities.
MYGAs – Interest rates directly affect MYGAs, as a MYGA offers you a pre-set interest rate for a certain period. The unique feature of the MYGA is that it guarantees the rate for the entire period of the annuity.
In that way, higher interest rates generally mean your return on the MYGA will be higher as well.
Fixed Index Annuities – Interest rates can have varying effects on fixed index annuities, depending on the specific fixed index annuity you have.
If you own a fixed index annuity that is designed for growth, then interest rates can have a primary effect. Insurance companies use call options to help fuel growth for fixed index annuity money. Options are impacted by interest rates to an extent, so they can affect fixed index annuities in that way.
If you have a fixed index annuity with an income rider, then interest rates will have a less pressing effect. In that case, life expectancy is again the bigger driver.
As before, your life expectancy at the time that you buy your annuity, and also the time when you start your income, matters.
Variable Annuities – A variable annuity is legally and structurally both a security and an insurance product. Variable annuity subaccounts let you directly invest in the market, so interest rates can have an indirect effect on variable annuity assets that way.
When interest rates go down, equity markets become more attractive for their growth potential. The opposite applies when interest rates go up. Markets can be less attractive when rates are higher and therefore more competitive (especially for the risk factor).
When you have an income rider attached to your variable annuity, life expectancy is still the primary influence. Your life expectancy at time of purchase and at income-start will have a big effect on annuity payments. Interest rates will have a secondary effect relative to that.
Can You “Time” Interest Rates for Purchasing an Annuity?
The short answer is pretty much no.
Annuities are based on long-term interest rates because they are long-term money-for-life contracts. Even annuities with a shorter maturity period are subject to this.
The last decade saw consistently very low long-term rates, for example. Because long-term rates can be challenging to predict, it’s even harder to determine when exactly is the “best” time for buying an annuity based on favorable rate conditions.
Moreover, the time you spend waiting for the perfect interest rate environment is deferred-growth time that you are wasting.
What Should You Do If You Are Worried About Interest Rates?
If you are concerned about low rates, you may wish to ladder your annuities. That consists of purchasing a group of smaller annuities over time. This technique staggers the ends of the contracts and allows for exposure to changing interest rates.
Remember, too, that your life expectancy is a primary factor in the pricing of your annuity. No matter what interest rates are, your age is your age. Indeed, waiting for a better interest rate also means that your life expectancy is decreasing, not helping the pricing of your annuity.
Life expectancy is an actuarial number. Life insurance actuaries constantly calculate these numbers and use them to price their products, including annuities.
The statistical knowledge of life expectancies is the basis for the pricing structure of virtually all annuities. That being said, interest rates and market performance can and do factor in.
Buy the Annuity with the Best Rates for You
You can use an annuity to accomplish almost any financial goal that requires a stream of income. Especially retirement income or lifelong income goals.
A prudent route for selecting and structuring that annuity is to work with a licensed professional to determine precisely what you need an annuity for – and how best to achieve those goals.
Then let pricing help you choose which annuity of the type you want you should buy.
If you are looking for someone to help you find the right options for your situation, many experienced and independent financial professionals are available here at SafeMoney.com. They can discuss your situation and go to work for you, searching for solutions based on your personal circumstances.
Get started by using our “Find a Financial Professional” section to connect with someone directly. You can request an initial appointment to discuss your situation and explore a potential working relationship. Should you need a personal referral, please call us at 877.476.9723.
