Does an Annuity Make Sense with Low Interest Rates?
Yesterday, I spoke with a Mr. Jim Lankford. Jim found our toll-free number on the web. He said he was 64, had recently retired and called to ask my opinion about whether he should wait until rates improved before buying an annuity.
In our conversation, I learned from Jim that he had been researching annuities for a year or so and was thinking of buying an immediate annuity with 30% of his 401k money. He said he was ready to go ahead but his former work colleagues kept telling him not to buy right now. They said he should wait until next year when interest rates will be higher. This, of course, would give him a better return.
As you'd expect, Jim's question is one I hear practically every day. Of course, I couldn't tell him where interest rates would be in a year from now. How could I know?
In which direction are interest rates headed?
On the surface, waiting for higher rates sounds very appealing. After all, most people believe the income they receive from an annuity depends on two factors: (1) the level of interest rates when they buy their annuity and (2) their age when they buy their annuity.
So, their reasoning goes, if I wait for interest rates to rise, I'll receive a larger monthly payment because I'll lock in a higher rate plus I'll be that much older.
There are, however, several problems with this line of reasoning.
First, you could be in for a long wait. The following is a chart of 30-year bond interest rates.
Imagine if you called me back in 1990 when interest rates were 8%. You'd have a memory of how high rates were just 5 years earlier, in 1985. They were 13%.
Do you think you would have locked in an 8% annuity rate in 1990? Or, would you have thought "An 8% rate is pretty low. I'm going to wait for rates to move back up to 13%."