Beware: How Low Interest Rates Impact Annuities

How to buy annuities when interest rates are low?

Annuities Beware: A conversation with several financial advisers recently with clients in or near nearby retirement centers is whether they should consider an annuity to fund part of their retirement income needs. Part of this conversation revolves around the current environment of low interest rates; which leads to lower annuity payments, all other things being equal. Here are some factors to consider when deciding whether any annuity is a suitable vehicle for customers in this environment.

Will raise interest rates?

This challenges the logic that the Federal Reserve will not raise interest rates; but there is no certainty about that, or at least not about when or by how much. If an annuity is the right choice for a client’s situation, factors other than interest rates should also be considered.

Fees and expenses

Full disclosure: I’m not a fan of most annuities, because so many contracts carry death rates and commission fees, stiff change fees, and other expenses that will apparently line the pockets of insurance companies and those who sell contracts. At the very least; advisors can help clients look at various options objectively, including without or low loads and low costs.

Change in life expectancy

Interest rates are not the only variable that affects the level of payments. Insurers use life expectancy tables to calculate payments for various scenarios; such as single life, co-existence and survivor, life and defined period, and a variety of other options usually available for annuities. Life expectancy and other factors may lead to changes in these tables that may work against customers and may offset the benefits of waiting until interest rates rise.

The purchase of annuities stairs

Ladder individual bonds are a general strategy. A similar strategy can be used when purchasing annuity products, such as immediate annuities with a single premium. Purchases can be made over several years in the hope that they will go for higher interest rates (and higher payouts). With the increasing popularity of deferred products, such as lifetime annuities, it is possible contracts with start dates can be purchased. This can help solve not only the problem of current low interest rates, but also inflation during retirement. Of course, there are no guarantees as to when the interest rates will be by the time the customer is ready to start paying the annuity.

Annuities Beware: Waiting has risks

The expectation of the product purchase annuity for as long as interest rates do not rise, also can carry risks. For example; if money intended to buy a contract loses value due to adverse investment results, customers may benefit from higher payouts from higher interest rates. But this can be more than offset by the lower premium amount available to invest in the contract.

Shop around

Annuity payments may vary between insurers for similar products, such as immediate annuities. Help your customers shop around to see where the best deals are located. However, it is always a good idea to be exposed to annuity payments that are significantly higher than those offered by most other insurers. This may be a sign of a weak company that is desperate to earn premium dollars. Although in rare cases, annuity contracts have been canceled, and disbursing funds can be a long and unpleasant process in these rare cases.

Look at the other parameters

Annuities can certainly be part of an overall retirement strategy for your client. But there are many other options. As a financial adviser, you have the opportunity to build a common approach to returning your clients to retirement. This means that you develop a financial plan that takes into account all of their investment assets; including retirement accounts such as their 401 (k), their individual retirement accounts (IRA), and other investment accounts. Social security and pensions must be well-considered as other sources of retirement income. Of course, annuities can play a role here.

Retirement from various client assets will entail factoring the best accounts from which funds can be withdrawn and the best sequence for setting those withdrawals. The client’s situation will need to be monitored and adjusted over time, and in some cases over a specific year; due to changes in their situation that may dictate changes this year.

While many argue that the benefits of annuities are a guaranteed source of retirement funding, in truth, the guarantee is no worse than an insurance company. Although there have not been many annuity defaults; the financial crisis of the past decade should at least cause financial advisers and their clients to question the financial soundness of any institution before relying on them to make these payments.

Bottom line

The current low interest rate environment makes it harder to decide to buy an annuity. And if so, when to buy and when to start payments. Financial advisors are in a great position to help.

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