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The Boomer

What Rising Interest Rates Mean for Annuities

By Casey Dowd The Boomer FOXBusiness

Annuities can serve to be an important leg in your retirement portfolio no matter what the current interest rates are. It is difficult to determine the perfect time to invest in an annuity, but with a projected hike in rates, it might be a good time to weigh the option.

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“Fixed annuities will appear more attractive than what investors have seen in recent years as interest rates rise. However, interest rates are expected to increase very gradually from record low levels so while they may appear attractive on a relative basis, fixed annuities will continue to offer low rates of return for some time to come,” said Bankrate’s chief financial analyst Greg McBride, CFA.

As to the advantages of fixed indexed annuities, McBride adds “these annuities are marketed as having the upside benefit of the stock market without the downside risk. However, the returns are capped so when the market rises significantly you are likely getting only a fraction of the return. Also, unlike investing in a broad based stock market index where 40% of the return over time has come from dividends, index annuities are based only on the price of the underlying index, and investors do not receive any of the dividends.”

Ken Nuss, CEO of AnnuityAdvantage, discussed with FOX Business what you need to know about rising interest rates’ impact on annuities, and how to create a guaranteed lifetime income stream.

Boomer: How do higher interest rates impact the value of annuities?

Nuss: The value of an existing, already issued fixed-rate annuity is not impacted when interest rates rise. The annuity value is determined by the initial deposit premium and accumulated interest earnings not yet withdrawn, compounding at a pre-determined interest rate for a set period of time, typically 3-10 years; all of which is contractually guaranteed by the issuing insurance company.

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Boomer: Given the current interest rate environment and outlook, would this be the right time to buy one?

Nuss: This is a question we hear often. In fact, it is a question we have heard often for nearly a decade. The problem with waiting for interest rates to rise is that no one knows for sure when rising rates will occur, how high they will go, and if those higher rates will be sustained or if they will fall back down.

Meanwhile, there are countless numbers of investors sitting on the sidelines, waiting for higher interest rates to develop, with their money parked in extremely low interest bearing savings and money market accounts, and they have been doing this for years.

For those individuals that still feel uncomfortable locking in today’s interest rates, we recommend a strategy of half now and half later. Take the funds that are being considered for fixed-rate annuities and commit half those funds now at today’s rates, holding the other half back in hopes of higher rates in the near future.

Boomer: Can you discuss some of the pros and cons of fixed indexed?

Nuss: Fixed indexed annuities are a type of annuity that credits interest based on the changes to a market index, such as the S&P 500 or Dow Jones Industrial Average. Interest is credited when the index value increases, but the interest rate is guaranteed never to be less than zero, even if the market goes down. Principal, as well as all previously credited interest earnings, can never be lost and are always protected from any unforeseen downturn in the market.

All fixed indexed annuity interest crediting formulas have some type of limiting factor that is applied to cause interest earnings to be based on only a portion of the change in the market index over the index term. In other words, in exchange for the added guarantees and principal protection, policy owners will not receive 100% of the index market gains. Considering the growing popularity of these products, it is apparent that many people feel this is a fair tradeoff.

Boomer: What are income riders and how are they impacted when interest rates change?

Nuss: An income rider is an optional benefit that can be added to some annuity contracts, usually for a fee, that is designed to help generate a higher level of guaranteed lifetime income at a future date.

Generally speaking, the higher the interest rate an insurance company can earn on its underlying investment portfolio, typically high quality corporate and government bonds, the more generous it can be to policyholders with regard to its income rider roll-up rates and/or lifetime payout percentages.

That being said, it ordinarily takes some time for those increased benefits to trickle down to an insurance company’s annuity offering and the changes are usually incremental rather than dramatic.

Boomer:  Should I roll my 401K into an annuity?

Nuss: This is a question that needs to be answered on an individual basis. It all depends on the retirement strategy and income goals of the individual, as well as the options provided by their existing 401k plan. If a particular annuity product more closely aligns with and better accomplishes the desired outcomes, then yes, it may make perfect sense to consider rolling over a 401k into a tax-qualified IRA annuity.

Most people only consider a 401k rollover upon separation of service from their current employer as a result of a job change or retirement. However, many 401K plans include a provision for in-service 401k rollovers upon attainment of a certain age, typically 59 ½. Individuals should refer to their 401k plan document or check with their plan administrator to research options. 

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