Understanding the relationship between annuities and interest rates can help you understand your policy. Changes in interest rates impact the value of annuities and discount rates for selling payments.
As any reputable financial adviser will admit, there aren’t any completely risk-free investments – including annuities. Fluctuating interest rates based on market conditions can make it difficult to determine the perfect time to invest in an annuity. However, one basic rule of thumb is that an annuity can serve as an important part of your investment portfolio, no matter what the current interest rates are.
If nothing else, using a lump sum of money to purchase an annuity helps you avoid squandering readily available cash on impulse spending. That’s true in any economy.
Interest rate fluctuations are inevitable. In the United States, the Federal Reserve Board sets rates for bank borrowing, often causing a ripple effect through the economy, as financial institutions react by setting new rates on all forms of borrowing, including credit cards and loans.
When interest rates fall, consumer spending generally increases, and that’s obviously good for the economy. Lower interest rates make it less costly to buy goods and services on credit, and the opposite is true when interest rates rise.
Annuities featuring regular, guaranteed cash payments provide peace of mind when interest rates are fluctuating. The same is true for structured settlements. For many people, the payments represent stable retirement income to keep their investment portfolios strong, even when other investments, such as savings accounts, may be paying smaller dividends because of a low interest-rate environment.
Annuity accounts grow faster when interest rates are higher, so as the owner of an annuity you can actually celebrate rising interest rates, assuming that you are also reasonably debt free and not locked into high interest loans yourself.
However, rising interest rates will eventually turn the other way, leaving fewer attractive investment options for investors. Buying annuities when interest rates are low could lessen the overall value of your investment and effect payouts. One option to avoid this is to simply wait for rates to rise again. But in a volatile economy it’s hard to predict when that will happen.
Another option in a changing economy is to just continue to wait. That’s not always the best answer, though. Without putting cash in any kind of interest-bearing account, mutual funds or stock investments, you will lose value in your portfolio over time because of inflation.
When an insurance company issues an annuity, it assigns a rate based on the current economic climate and type of contract you purchase. The rate in your contract reflects how much your annuity will grow during its lifespan. Described another way, it determines how the premiums you pay affect your annuity’s growth.
With fixed annuities the rate remains stable. There is a stated interest rate at purchase, and it’s guaranteed to stay at the same. This protects you from the volatility of the market.
The terms of variable annuities can change. The means how much you earn every year can either increase or decrease in value based on the performance of the annuity issuer’s mutual fund accounts.
Every contract comes with a stated interest rate. It may be a set figure or a variable one with a minimum and maximum rate. Either option could be good or bad, depending on the market. Some people are wary of purchasing fixed, deferred and income annuities when interest rates are low, as these investments could feature terms that are locked in at a relatively low rate of return.
Experts maintain that annuity sales spike as interest rates increase, meaning greater gains for investors and those selling annuity payments. With an improving economy in 2015, rates are expected to rise following an extended period of historic lows as the American economy continues digging out of its post-2007 slumber.
Annuity sales – especially fixed annuities sales – grew in 2013 compared to the previous four years. “Interest rates during most of 2013 had a positive impact on the insured retirement marketplace,” said Cathy Weatherford, president and CEO of the Insured Retirement Institute (IRI).
IRI officials say immediate and deferred annuity owners received higher payments because of raised interest, fixed deferred annuities offered higher crediting rates, and fixed indexed annuity caps and participation rates increased.
Experts say you can guard against interest rate fluctuations by having a balance of high-yield and guaranteed investments. Depending on the other elements in your portfolio, an annuity may be the key to anchoring your investments.
Consider investing in new annuities gradually, spreading purchases over time to take advantage of potential increases in interest rates – a tactic known as annuity laddering. Investors also purchase bonds and CDs as laddering strategies to account for future changes.
Annuity sales will continue rising as interest rates improve, meaning that brokers, investors and some consumers could see greater gains in their financial portfolios in the coming years.
The bottom line: Financial experts suggest buying annuities when interest rates are high to lock in higher payments—but not waiting too long if rates remain stagnant.