Interest Rates Are Rising, Should I Wait To Buy My Annuity?
Timing an annuity purchase can be stressful. This is especially true if you are hoping to predict future annuity rates. Many people assume increases in the so-called “Fed-Rate” will increase annuity payouts as well. So, since the Fed announced it plans to increase rates, shouldn't you wait to buy your annuity? That’s not necessarily the case. The answer to this question may surprise you.
The “Fed Rate”
To understand what causes changes in annuity rates, we’ll need to step back and consider how insurance companies invest. An insurer wants an investment that is going to be stable over a long period of time. After all, they are investing to cover the golden years of many retirees. For some people this could be 30 years or longer!
To do this, insurance companies invest a large portion of their assets in high-quality bonds. They choose these types of investments for their predictable stability. Since annuities are long-term contracts, their payouts correlate with long-term rates. As a result, annuity rates closely follow bonds with a duration of 20 or more years.
The chart below shows payout rates for Life with 10 Years Certain annuities and Moody’s Aaa Rated Corporate Bonds with maturities of 20 years and above.
Single Life With 10 Years Certain Annuity Payouts and Moody's Aaa Corporate Bond Rates
But, long-term bond rates don’t fluctuate as much as short-term bonds rates do. While short-term bonds and the Effective Fed Rate may move in tandem, long-term bonds generally follow the Effective Fed Rate's trend but not its every movement.
In other words, the Fed Rate may influence the general trend in annuity rates, but they don’t determine them. So you may be waiting quite a while to see that Fed-Rate increase affect annuity rates.
To illustrate this, below we have a graph of the Effective Federal Fund Rate, 1-Year Treasury Notes and Moody’s Aaa Rated Bonds. Remember, annuities correlate with the Moody’s rate in black.
Effective Federal Fund Rate, Short-Term 1 Year Bond Rates, And Long-Term Moody's Aaa Corp. Bond Rates
Live Long and ProsperWith a lifetime annuity, how long you live affects how much money you make. This is a key point to understand. If you wait a year for rates to increase, that’s one less year of income you earn.
For waiting to make sense, increases in your payout rate need to make up for this lost income. Let’s consider a hypothetical situation.
Frank is 64 years old and wants to buy a $100,000 Single Life with Cash Refund Immediate Annuity. As of August 2018, he would get about $500 each month. But what if he were one year older, rates went up by a little over 3%, and he was getting $528 per month? He would be getting $28 more per month! But Frank would have also missed out on $6,000 of payments while he waited for rate increases.
To make up for lost income, Frank would have to live at least 18.9 years. We calculate this by dividing $6,000 by $28, and then convert those 215 months into 17.9 years. But then we also need on the year Frank didn't get income. We wish Frank a long life, but according to the CSO Mortality Table his life expectancy is only 16.80 years.
Hypothetical Accumulated Income Comparison of Waiting One Year to Begin Income Frank's Life Expectancy: 16.80 years Time To Recover Income: 18.90 years
This doesn't mean that waiting is always a bad idea. The uncertainty of future annuity rates and how long you will live means there is no 'right' or 'wrong' choice. And, there are strategies to protect you from locking in a low rate while not missing out on earning income. You can read about one of these strategies, annuity laddering, or call one of our experts at 800-872-6684. We’re happy to help you plan your annuity purchase.