James Philpot: Inflation, Interest Rates and Annuities

Welcome to the Annuity.org Podcast, your path to financial freedom through better understanding annuities, selling structured settlements, personal finance and retirement planning. I’m Terry Turner, and joining me on this episode is Dr. James Philpot, director of the Financial Planning Program and associate professor in the finance and risk management department at Missouri State University in Springfield, Missouri. We’ll be discussing inflation, interest rates, annuities, and how all of these three things work together. Thanks for joining us, Dr. Philpot.

Well, it’s my pleasure.

We’re going to be talking about inflation, interest rates and annuities, and how all of these kind of work with one another. Overall, how has this current bout of inflation and interest rate hikes affected retirement planning for people?

I think it has thrown a whole lot of uncertainty into the mix. This is a topic I’m intimately familiar with because I too am looking at making a retirement decision. So when I was looking at retiring, say 8-10 months ago, things were pretty confident, things were good, and then we get hammered with some of the individual month reports of inflation rates of 8, 8.5, 9, 9.5% and all that, and that really throws a monkey wrench into things, planning for the prospect that, oh, year over year, I could be seeing a 10% decrease in my buying power. That’s very heartening, and it makes someone who was really thinking that retirement was imminent, think twice and, “Oh, maybe I should probably work another year or two.”

This current era of inflation is something new, something of a new experience for a lot of people out there. I can remember having a home mortgage of 13% years ago.

Oh, wow.

Can you tell us some of the basics?

Then you’re about my age, or maybe a little older, I’d take it.

Yeah, thereabouts. I kind of figured that. But we’ve been there, we’ve seen that, so it’s not as surprising to us as a lot of people though. A lot of people who are making …

Yeah, I remember the very first investment I ever made. I was a youth, and I sold my motorcycle and scraped together $1,000, and I bought an FDIC-insured six-month certificate of deposit at a bank, and it was paying 17.75%.

Wow. Those were the days.

We thought it was the end of the world, and for many of those banks, it was the end of the world.

Yeah. For people who aren’t familiar with that, for whom the current bout of inflation we’re having is a completely new experience, can you tell us some of the basics about what you’ve got to take into consideration to get into retirement, to save for retirement, and how this can maybe just be a bump in the road or it can be a life-changing event for a lot of people?

Let’s just kind of go at it chronologically. If you are a younger individual, say a 20 something, 30 something, this really highlights a lot of the mistakes, investing mistakes are probably the biggest investing mistakes that the 20 something, 30 something set make, and in fact, I made one of those to myself the first being not investing enough toward retirement, not having a very good retirement investing program in place. The advice on that is if your employer offers the 401k, 403b, whatever, participate, maximize the employer match, try to do what you can into your IRA, so there’s that one. But then another thing that I fell victim to early on was being way too conservative in my choice of long-term investments toward retirement. Really, if you’re a 20 something, unless you really have something going on, some kind of shorter time horizon, a real strong reason for that, or again, if you somehow are just really unfamiliar with investing, investing products, perhaps as a result you have extreme intolerance for risk, you really don’t have a lot of business being heavy into fixed income, bond, bank accounts, CDs, things like that. You really should be looking to do something that will give you a shot, giving a little bit more risk of staying ahead of inflation rates. For younger folks, those are really my two bigger things.

What should you think about closer to retirement?

Let’s evaluate lifestyle. Let’s start really planning. What kind of retirement lifestyle am I looking at and how much is that going to cost?

Our primary focus is annuities. That tends to work for people who are closer to retirement, tends to be an area of interest for people closer to retirement. How does inflation and inflation’s companion higher interest rates play into your thinking about annuities as you near retirement?

As I get closer to retirement, I’m watching those interest rates, annuity products, again, depending on the type of annuity, if you’re looking at a fixed annuity, which is making a fixed dollar amount of payment over the rest of your life, that’s a very interest sensitive product in terms of if interest rates are extremely low, the payout every year is going to be extremely low. A lot of financial advisors over the last several years before pandemic were rather hesitant to put people into fixed annuities just because the payouts were so unattractive. Plus, those types of payouts being fixed would be very sensitive to increased inflation, largely because they’re the kind that would quickly lose their purchasing power. That is, if I’m getting a fixed $1,000 a month out of an annuity, we have a round of 9% inflation, then I’m only getting $910 worth of purchasing power from here on in out of that $1,000.

Interest rate hikes have been making some annuities more attractive lately, though, haven’t they?

If we’re watching inflation and watching perhaps inflation work its way through interest rates, by increasing interest rates, which is interest rates common response to inflation pressure, the annuity product, once the interest rates rise, can become more attractive that the fixed annuity product can, because it will be promising higher payouts. Variable annuity, a whole different ballgame because those products are actually designed to keep pace with inflation in exchange for taking some investing risk.

How effective are variable annuities in addressing the issue of inflation when it comes to buying an annuity?

When it comes to buying an annuity, again, what you’re doing in a variable annuity is you are buying a piece of a portfolio that is invested in more risky assets. For example, say dividend producing common stocks as well as bonds. The idea is that over time, the returns on the riskier portion will stay ahead of inflation. Now, individually speaking, it’s just a question of the underlying asset portfolio of those annuities. Some have maintained with inflation quite well, others well less, but that’s the basics of what’s going on, and really for the right type of person, part of their retirement portfolio in some kind of variable rate annuity could make a good move.

How does a variable rate annuity compare to say, a cost-of-living rider on another annuity to deal with inflation? Is there one that’s better than the other, or are they pretty much the same thing?

Well, the purpose is pretty much the same. You’re trying to hedge against inflation. In the one, in the cost-of-living rider, you’re basically taking a fixed annuity, you being the consumer, and you’re willing to accept a start off lesser annuity payout with the promise, in exchange for the promise that, “Oh, this will rise at cost of living.” Now, the variable annuity on the other hand, doesn’t really make that promise, but it will invest the proceeds, the principal amount, of that annuity into these riskier income-producing assets, again, with the hope that will stay ahead of inflation, the prospect that we may well stay up with inflation, but the prospect that will stay ahead of inflation. The basic purpose is the same. The way they go about achieving that, pricing that is different. The investment characteristics really for the customer are different.

Dr. Philpot, thanks for joining us.

Glad to do it.

Dr. James Philpot, associate professor in the finance and risk management department at Missouri State University. We’ll continue our discussion of inflation, interest, rates and annuities in our next episode. Right now, thank you for joining us on this episode of the Annuity.org Podcast. For more information about annuities, personal finance, anything else we talk about here, check out Annuity.org, your path to financial freedom. You can subscribe to Annuity.org Podcasts for free available wherever fine podcasts are found. Our theme music, “Feeling Good,” was produced by White Hot, available at freebeats.io. I’m Terry Turner for Annuity.org.