What is an Annuity Rate?

Written by Hersh Stern Updated Wednesday, July 29, 2015

annuity rates

How do you know which annuity rates you find on the internet are the best for what you have in mind as you plan your retirement?

The answer is there's no way to compare the different annuity rates you find on the internet unless you understand the six main types of annuities these rates are advertising. This article summarizes the main features and drawbacks of each of these annuities.

To start, it's important you know that each type of annuity described below can be further separated into two categories; fixed and variable.

By “fixed” annuity we mean that your premium (or investment) compounds at a fixed or stated interest rate; by “variable” annuity we mean your investment can increase or decrease in value based on the performance of an underlying mutual fund account.

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1. Fixed Immediate Annuities

Fixed immediate annuities typically offer you a ‘fixed’ income stream for the duration of your lifetime by paying you some of your original principal plus earned interest each month. This type of annuity is designed to produce income by liquidating the principal during the annuity owner’s lifetime. The amount of each monthly payment from an immediate annuity is typically greater than the amount withdrawn from other types of annuities because in those annuities you are only receiving the interest earned from the investment (and leaving the principal of that investment intact). Whereas, from the immediate annuity, you receive a portion of the underlying investment, also.

Immediate annuity income streams can be set up to pay out for a limited or specified period of time, for your lifetime, for you and your spouse’s lifetimes, or any combination of the above. And, the income stream can be delivered monthly, quarterly, semi-annually, or annually dependent upon your financial needs.

Annuity rates offered for immediate annuities will vary based upon age, gender and the type of payout stream selected. Keep in mind, when you receive an immediate annuity quote, the figures will express how much income you will receive over the chosen time frame or period, not the underlying rate of return your investment will earn.

2. Deferred Fixed Annuity Rates

A deferred fixed annuity works similarly to a bank certificate of deposit (CD), but it is not covered by FDIC. These annuities are offered by insurance companies and their rates are quoted as an “Effective Annual Yield.” You will be given the option to choose the guaranteed income period, typically between three and ten years. In most cases, you will be offered a higher annuity rate for holding your contract in place for a longer period. So, to distinguish deferred annuities from immediate annuities, we have that deferred annuity rates are based largely on the length of the period you are holding the annuity for whereas immediate annuity rates are based on your age, gender, and the selected time frame over which you receive payments (which can be as short as five years or as long as you and your spouse’s life expectancies).

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We had heard about annuities and were investigating them for our IRAs. We also heard bad things about pushy brokers over the years. So when we went to the ImmediateAnnuities.com site we were skeptical about calling them. But whenever we called their staff was really friendly. They answered all our questions and one of their reps even told us that at our ages there was no advantage to buying the annuity with our IRAs. These guys are really honest!
Fred and Gloria Pollard
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3. Deferred Income (“Longevity”) Annuity Rates

Deferred Income Annuities (DIAs) combine features of both the immediate annuity and the deferred fixed annuity previously discussed. If you want to create guaranteed income for a later date consider a DIA. Deferred income annuities combine the investment growth period offered by the deferred annuity with a selected income period as with the immediate annuity. The investment growth period options vary between three and thirty years depending upon the insurance company receiving quotes from. When you receive a deferred income annuity quote, you will be provided with the income stream’s start date and the ability to select designated beneficiaries. The quote received will not state the underlying investment return but the annuity’s deferral period, your chosen income stream option, the estimated monthly or annual income stream and the date in which this income stream will begin. It is important to note that if you die during the selected growth period, your beneficiaries may not be guaranteed to receive your investment. Be sure to read the features of the annuity contract quoted.

4. Secondary Market Annuity Rates

From time to time, the owner of an immediate annuity may opt to sell their future income stream for an immediate lump sum payout. When such a pre-owned annuity is available for purchase we call that a Secondary Market Annuity (SMA).

Annuity rates for secondary market annuities are often based on the interest rates in effect at the time the original annuity was created. For example, if interest rates were 7% in 2000 and an immediate annuity issued in 2000 were to become available for purchase today, the annuity rate quoted for such an SMA would be 7%, regardless of whether current interest rates are higher or lower. Please keep in mind, that as with immediate annuities, the annuity rate quoted on an SMA should not be confused with that annuity’s payout rate (which is usually higher since it includes the principal portion of the payment received in the calculation of “payout” rate).

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I contacted Immediate Annuities.com to buy my annuity. They were prompt, very responsive, paid attention to detail, understood my objectives, and were superb when it came to staying on top of seeing the funds transfer and issue of new policy documents through to completion.
Dr. David Babbel Professor Wharton School
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5. Fixed Index Annuity Rates

Fixed index annuities share similar features with fixed deferred annuities; however, their annual growth is tied to a benchmark stock index versus a fixed rate of return. An index annuity’s growth rate is subject to rate floors and caps, meaning they will not exceed or fall below specified returns even if the underlying indexes fluctuate outside the set parameters. In simplest terms, the insurance companies bear the risk of a sharp stock market decline with this type of annuity. The spread between the floor and caps typically ranges between three and seven percent and will vary based upon the insurance companies offering quotes.

6. Variable Annuity Rates

Variable annuities do not offer fixed rates of return. The performance of these annuities is directly tied to the market returns of the investment sub-accounts selected. Think of a sub-account as individual stocks or mutual funds. Their value will fluctuate based upon current market conditions, meaning your investment growth is dependent upon the sub-accounts selected. When you receive a quote or illustration for a variable annuity it will be expressed as hypothetical rather than guaranteed which is only true for fixed annuities.

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Comments (12)

  1. Mehran:
    Jun 04, 2015 at 01:45 PM

    What is the management fees involved?

  2. Hersh Stern:
    Jun 04, 2015 at 01:46 PM

    Hi Mehran-

    Management fees typically apply to actively managed accounts like variable annuities. There are no management fees, however, with immediate or deferred income annuities. The amount quoted is literally the amount of income you receive each month.

    -Hersh

  3. Michael:
    Jun 24, 2015 at 07:26 AM

    I am leaning towards purchasing a variable immediate annuity since the payouts on the traditional immediate annuities are relatively low.

  4. Hersh Stern:
    Jun 24, 2015 at 07:29 AM

    Hi Michael-

    A variable immediate annuity (“VIA”) could make sense. Essentially, with a VIA, the insurance company divides your premium into two “accounts.” One account or allocation is used to generate a base level fixed monthly payment (which would be similar to buying a traditional immediate annuity with that portion of your premium). The other portion is allocated to growth assets (stocks). As long as the growth portion is increasing in value year after year you’ll receive a pass-thru of some of that year’s gains in your next year’s monthly income.

    Keep in mind, however, that only a fraction of the annual gains can be distributed to you in any year because the rest needs to remain allocated to the market otherwise there’s no opportunity to capture gains.

    Also, in the 15 years since the stock markets peaked (roughly in 2001) they have been range-bound. For example, the NASDAQ in June, 2015 is only now getting back to the level it was at in 2001. Similarly, the Dow Jones Industrials have been fluctuating between 7,000 and 18,000 (back and forth 3 times since 2001). So few VIAs have made any headway during this period.

    In retrospect, you would have received a lot more monthly income between 2001 and 2015 if you had locked in a traditional immediate annuity at 5%-6%, which is where rates were back in 2001.

    I know hindsight is 20-20. But it’s good to keep some perspective on how a VIA might work out for you if the stock market remains range-bound for another 10 years.

    Hersh

  5. Ernest:
    Jul 16, 2015 at 02:12 PM

    You sent me quotes for a 5 Years Period Certain annuity for $100k. I did the math and calculated the return to be 0.44%. Not good and in the range of current CDs. What am I missing?

  6. Hersh Stern:
    Jul 16, 2015 at 02:14 PM

    Hi Ernest,

    On the amortization schedule I included with your quotes, you'll see that it shows you in detail each month’s earnings and withdrawals, for each month during the 5 years. You can follow the math line by line. The correct interest rate for this amortization spreadsheet is 0.88%.

    I think the reason you came up with an interest rate that was half my rate is that your calculation assumed the insurance company had the use of the full $100,000 premium during all 5 years. That’s just not true with an immediate annuity. Each month the company distributes to you a large portion of the principal. So the company on average has only $50,000 of your money on which to earn interest.

    This also explains one of the chief differences between an immediate annuity and a CD.

    A CD is not “breakable” each month. You cannot withdraw principal from it the same way you can with the annuity. A more realistic rate comparison would be between the annuity and a money market account and those interest rates are lower than the annuity rates.

    Of course, bank CDs and money market accounts are FDIC insured, which is an important advantage annuities don’t have.

    Hersh

  7. Bob:
    Jul 27, 2015 at 10:15 AM

    If the 10 year treasury were to go up 1%, approximately how much would Met Life’s monthly payment go up by? My quote has it paying $415 a month for a Life with Cash refund. I just want to get a feel for how important rates are when purchasing an annuity.

  8. Hersh Stern:
    Jul 27, 2015 at 10:16 AM

    Hi Bob-

    I’ve been tracking interest rates and annuity payouts at our site for years – take a look here:

    https://www.immediateannuities.com/annuity-trends/

    A 1.00% change in Moody’s AAA bond index leads to about a 10% change in monthly income for a 65 year old (based on $100k). So in your situation I’d estimate there would be about a $41 per month increase plus/minus.

    Hersh

  9. Phillip:
    Aug 07, 2015 at 02:03 PM

    I bought an immediate annuity a few years ago when interest rates were higher. Is it possible to put more money into that annuity policy to get the same rate? Or do I need to get a new policy if it’s with the same insurance company?

  10. Hersh Stern:
    Aug 07, 2015 at 02:04 PM

    Hi Phillip-

    Good try, but, immediate annuities are only sold as “single premium” products. That means the higher interest rate you locked in years ago applied only to the initial premium amount.

    Unfortunately, when rates go down, insurance companies are reluctant to let investors deposit more money at the older rates because the companies themselves are investing today at rates which are lower than they were years ago.

    There is a type of annuity called a “flexible premium” policy which accepts additional deposits into the same account. However, even with that type, the money you deposit today will be credited with today’s interest rate, not the higher (or lower) rate that was in effect on the day you initially bought your policy. And immediate annuities are never sold as “flexible premium” policies.

    Hersh

  11. Marianne:
    Aug 28, 2015 at 07:10 AM

    Is the interest rate for an immediate annuity set for the lifetime of the annuity? What is the current interest rate? Thanks.

  12. Hersh Stern:
    Aug 28, 2015 at 07:11 AM

    Hi Marianne-

    The answer to your first question is, yes. When you buy an immediate annuity you are locking in an interest rate for the lifetime of your annuity.

    Regarding what interest rate was credited to the single life annuity, I’m afraid there is no exact answer I can give you. I’ll explain.

    In order to determine an annuity’s interest rate, you need to know up front how many payments you’re getting in return for the investment. But with a life annuity no one knows how many payments they’re receiving. That number will only be known after the annuitant has died.

    So, a lifetime immediate annuity has an indeterminate payout period. Only in hindsight do we know if you received few payments or many payments, all depending on how many more years you lived.

    With that said, let’s make some assumptions about how long you *might* live and for how long you *might* be receiving payments. We’ll calculate interest rates based on the quote of $655 a month.

    If you live another 20 years, until you reach age 83 and payments stopped, then your interest rate (in hindsight) would have been 2.00%.

    If you live another 25 years, until age 88, your interest rate would have been 3.55%.

    Hersh