The Federal Reserve promised to reduce interest rates once it’s sure inflation has cooled sufficiently. For retirees who hold or are considering buying interest-sensitive fixed annuities, a rate cut could have significant implications.

So what should they do to prepare for rate cuts?

“Interest-rate reductions will likely result in lower rates on fixed annuities than what is being offered in the marketplace today,” says Brian Sward, executive vice president and head of product solutions at Jackson National Life Distributors in Franklin, Tenn.

Therefore, he says, retirees might want to consider locking in current rates now, before the Fed acts. “Most fixed annuities have terms of three-, five- and seven-year durations, so there could be advantages to purchasing fixed annuities prior to interest rates declining,” he says.

For those who hold these period-certain annuity contracts, an interest-rate drop means “the renewal on the annuity would be at a lower rate,” explains Howard Sharfman, senior managing director at NFP Insurance Solutions in Chicago. Clients might benefit from shopping for a new product “before the account renews automatically and resets at a new rate,” he says.

Current Fixed Annuities Won’t Change
On the other hand, fixed annuities will keep their current rates regardless of the Fed’s rate tightening. So clients who own annuities with a guaranteed payout that doesn’t expire or reset need not worry. “With this [type of] annuity, a decrease in interest rates would not affect the payment,” Sharfman says.

“A Fed interest-rate reduction is unlikely to have much, if any, negative impact on existing annuity holders,” says Elle Switzer, director of annuity product management at TruStage in Madison, Wis., echoing Sharfman’s sentiment. “Annuities are long-term investments backed by long-term fixed-income assets, so current yields will not have a material impact on the in-force annuity.”

She further pointed out that the value of annuities is not dependent on or a function of prevailing interest rates. “A higher-rate environment certainly can lead to annuities being able to provide higher guarantees,” she says, “but the benefits of an annuity are not diminished if the Fed reduces rates.”

She cited their “unique ability to provide accumulation or income-for-life guarantees. Interest-rate environments do not change these fundamental benefits.”

“It’s never a bad time to make a good investment,” says Mike Harris, senior education advisor at the Alliance for Lifetime Income, an industry group in Washington, D.C. “Higher interest rates do provide more attractive annuity returns, [but] rather than playing a guessing game trying to time interest rates or the markets, it’s far more important to base the purchase of an annuity—any annuity—on your exact needs, financial situation and the retirement phase you’re in.”

Micah Schmidt of Prime Capital Investment Advisors in Overland Park, Kan., puts it this way: “Nobody should purchase a fixed annuity based solely on the expectation of declining rates,” he says.

Weighing The Annuity Decision
Indeed, advisors stress that annuities are simply not right for everyone, no matter where interest rates are.

“Assuming that purchasing an annuity makes sense in [a client’s] overall financial plan, then certainly yes—it makes sense to purchase annuities now before rates fall and annuity benefits decline,” says Ward Keever, president and CEO of Covenant Wealth Strategies in Wilmington, Del.

Nevertheless, rate reductions “should not be the driving decision for the purchase,” says Teodor Panaitisor, a senior research analyst at data-tracker Limra in Windsor, Conn., though he adds that interest rate changes “may have an impact on the payout or crediting rates of the [annuity] contract.”

Still, the expectation of a change in Fed policy can be a good moment to reconsider whether an annuity fits with a client’s specific needs and preferences, says David Blanchett, the Lexington, Ky.-based head of retirement research at PGIM, the investment management group of Prudential. “It’s worth understanding where a retiree sits in terms of retirement,” he says, adding, “Re-evaluating a portfolio right now makes sense.”

Other Annuities
Changes in interest rates can affect other types of annuities, too.

“Rate reductions, depending on how steep [they are] and on other factors such as equity market volatility, could result in reductions in cap and spread rates on fixed-indexed annuities and registered index-linked annuities,” says Frank O’Connor, vice president of research at the Insured Retirement Institute in Washington, D.C. Both of these annuities are linked to market performance and, to varying degrees, limit the upside potential and downside risk.

O’Connor says that lifetime withdrawal benefit riders on variable annuities might also be affected by interest rate declines. These riders offer optional cash advances on the value of the annuity, regardless of whether the annuity has declined as a result of market losses. Lower interest rates could reduce how much can be withdrawn at a particular time, O’Connor says.

Interest-Rate Forecasts Shouldn’t Matter
If you miss the boat on rate reductions, don’t worry, some advisors say.

“Interest rates are truly one of the hardest things to forecast,” says Wade Pfau, Dallas-based director of retirement research at McLean Asset Management and a professor of practice at the American College of Financial Services. “Try to avoid having any sort of forecast for interest rates enter into [the annuity-purchase] decision.”

In fact, he says, fixed annuities actually offer a better relative value when interest rates are low. That’s because of what’s called longevity pooling or mortality credits, since annuity payout rates are partly based on each annuitant’s life expectancy at the time of purchase. Interest rates are only part of the payout calculation—whereas rates have more of a total impact on Treasury bonds, money market accounts, and certificates of deposit.

“Rate reductions can affect all types of fixed-income solutions,” says David Wood, vice president of brokerage distribution for Lincoln Financial in Greensboro, N.C. But only annuities provide the advantage of mortality credits, he says.