Key Takeaways
- Annuity rates rose in 2022 and 2023 largely because of the Federal Reserve’s interest rate hikes.
- If the Fed decides to lower interest rates, as some economists have predicted they may in 2024, annuity rates may not stay as high as they have been.
- Delaying an annuity purchase to try and hold out for a higher rate can result in lost accumulation time or missing out on a high rate if rates eventually fall.
Rates for fixed annuities rose steadily throughout 2022 and 2023 after remaining stagnant in the previous years. The trend has continued into 2024, with average 5-year annuity rates increasing from 5.33% in December 2023 to 5.55% in April 2024.
The rise in annuity rates (particularly when compared to similar products such as certificates of deposit) spurred a surge in sales of fixed annuities in 2023. According to trade group Limra, fixed deferred annuity sales totaled $164.9 billion in 2023, beating 2022’s record sales by 46% and more than tripling the $53.1 billion sold in 2021.
Despite this unprecedented growth in annuity sales, Limra predicted that sales in 2024 would not outpace the previous year. Limra’s report cited an expected decline in annuity rates as one reason for the predicted lower sales.
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How Do Interest Rates Affect Annuity Rates?
Generally, fixed annuity rates rise and fall parallel with larger interest rate trends. The trend in stagnant annuity rates during the years of the COVID-19 pandemic, along with the rising annuity rates over 2022 and 2023 mirrors the fluctuations in Federal Reserve interest rates in those years.
When the Federal Reserve raises interest rates, the interest earned on bonds also increases. Bonds make up the majority of many annuity insurers’ portfolios. The insurance company takes fixed annuity premiums, invests them in bonds and other low-risk securities, and credits interest to the annuities based on the returns of those securities.
Because Federal Reserve interest rates influence bond returns, and those bond returns affect the rates for fixed annuities, the Fed’s interest rates can be considered an accurate indicator of which direction annuity rates are likely to go.
At the beginning of 2024, many economists and financial experts predicted that the Federal Reserve would slash interest rates after raising them consistently in the previous years. However, as of April 2024, the Fed has signaled that interest rates may not be lowered for some time.
During a policy forum on April 16, 2024, Federal Reserve Chair Jerome Powell said that inflation has yet to recede to the Fed’s goal of 2%, indicating that interest rate cuts are unlikely to happen anytime soon.
If interest rates remain stable throughout 2024, it’s reasonable to expect annuity rates to stay similarly consistent. However, if rates decline later in the year, this could result in a drop in fixed annuity rates.
If you are interested in purchasing an annuity, but are contemplating whether to buy now or wait for interest rates to rise, revisit your holistic financial plan. Perhaps, an annuity is sensible for you, but it may not make sense to put all your money into one. Rather, an annuity could be a nice complement to a portfolio of stocks, bonds, alternative investments and cash equivalents.
Thomas J. Brock, CFA®, CPAInvestment, Corporate Finance and Accounting ProfessionalThomas Brock, CFA®, CPA, is a financial professional with over 20 years of experience in investments, corporate finance and accounting. He currently oversees the investment operation for a $4 billion super-regional insurance carrier.
What’s the Cost of Waiting for Annuity Rates To Rise?
No matter what you choose, the decision to buy an annuity now or to wait for interest rates to rise comes with risks and rewards. When choosing financial products like annuities, consider the opportunity cost.
Opportunity cost refers to the value lost when you choose an alternate course of action. In other words, when you delay purchasing an annuity — or investing your money in some other way — you lose the value of the foregone growth on those funds. And if the funds had the potential for exponential growth and income tax deferral, the financial loss may be greater than you think.
Future Uncertainty
Perhaps the most glaring issue is that you can’t know that interest rates will actually rise in the future.
As previously mentioned, the Federal Reserve’s monetary policy largely influences interest rates as it seeks to stabilize the economy. We can’t predict either the economy or the Fed’s reaction to it. Interest rates may rise, fall or even remain flat for very long periods of time.
Lost Time
If you own a deferred annuity, waiting to buy means missing out on potential growth.
“Deferred” refers to the fact that payments begin in the future, rather than immediately after you purchase the annuity. During that time, your annuity may grow according to the terms of your particular contract. Your interest will likely compound, although some annuities pay simple interest.
When you have an investment that allows for compound growth, interest is added to your principal. If your interest is compounded annually, for example, the first year, you will earn interest on your initial investment — in terms of an annuity, this would be your premium — in the first year. In year two, your interest will be calculated on the balance at the end of year one, and so on, for the duration of the contract.
If you wait to purchase, you miss out on the time your annuity could have accumulated that compound interest.
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If you wait to purchase your annuity, you’ll need to be sure that whatever you decide to do with that money is expected to grow faster than the annuity would have. Otherwise, you aren’t better off.
Keep in mind that annuities also have the benefit of growing tax-deferred. You don’t have to pay tax on it until you begin receiving your payments.
Real-World Example: What You Could Lose by Waiting
Several factors influence the potential loss you could incur by waiting for interest rates to increase. The most significant factors include the type of annuity you buy and the interest crediting method the insurer uses to determine how interest is handled.
Imagine you’re interested in a multi-year guaranteed annuity (MYGA) purchased with a lump-sum premium of $100,000 that guarantees a 2.4% interest rate for five years and would grow in value to $112,589.99 by maturity.
If you wait a year to buy this type of annuity, you must secure a 3% interest rate to accumulate the same value by your target date.
This example won’t apply to every type of annuity. You have other options, including putting your money in a high-yield savings account for a year and purchasing an annuity with a higher premium.
To illustrate, imagine depositing that same $100,000 into a high-yield savings account that offers 1.0% for one year. You would have an additional $1,000 after the year is up. If you then put the entire $101,000 into a four-year MYGA, you would need a lower 2.75% interest rate to accumulate $112,576.75 by your target date.
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