In February, the Federal Reserve raised interest rates for the eighth time in the preceding 12 months—and indicated that more rate hikes may be coming.
Consequently, six-month Treasury bonds were yielding slightly less than 5%, while 10-year Treasurys were just under 3.5%. But it was fixed annuities that had some clients and advisors excited.
Clients who bought a four-year fixed annuity, for example, could lock in a 6% guaranteed annual return without any additional fees, according to Tim Rembowski, vice president at DPL Financial Partners in Louisville, Ky. One year ago, he says, when interest rates were lower, the return on these products was closer to 3%.
“Fixed annuities have been a huge bright spot in portfolios,” says Rembowski. “We see many advisors and clients who view annuities today as a great buying opportunity.”
But that may not be true for all clients.
Not All Alike
“It’s important to consider what the annuity is expected to do when assessing its attractiveness in relation to interest rates,” Rembowski acknowledges.
Before buying an annuity, clients and advisors should be “well educated on the type of annuity they are reviewing,” says Ara Diloyan, a vice president and financial planner in the private client group at Sentinel Group in Wakefield, Mass. “Not all annuities work the same.”
Fixed-rate deferred annuities, which are traditional, straightforward, income-producing contracts, have been the big sellers lately. In the fourth quarter of 2022 alone, their sales soared 241% year over year to $37.5 billion, as measured by LIMRA’s “U.S. Individual Annuity Sales Survey.” That was the best quarter for these products ever recorded by the Windsor, Conn.-based data tracker. It drove a 22% year-over-year surge in total annuity sales for the year, to $310.6 billion, 17% higher than the record set in 2008, according to LIMRA.
The primary reason was rising interest rates. “Rising interest rates will typically have an immediate impact on fixed annuities, as insurers can quickly modify their crediting rates to reflect the rising rates,” explains Todd Giesing, assistant vice president of annuity research at LIMRA.
Fixed Vs. Variable Annuities
Fixed annuities pay a contractually guaranteed amount for a specific period of time. They are most directly linked to interest rates.
Variable annuities, on the other hand, invest in mutual-fund-like subaccounts that rise and fall with the stock and bond markets. Subaccounts that invest in bonds are more directly impacted by interest rates.
But VAs typically offer optional “living benefit” riders for an extra fee, such as lifetime income guarantees. As interest rates rise, these benefits “will likely start to become more generous,” says Frank O’Connor, vice president of research at the Insured Retirement Institute in Washington, D.C.
Cap And Crediting Rates
Other types of annuities may also pay more.
Fixed-indexed annuities, for example, reward account holders with a percentage of an index’s gains, in exchange for complete downside protection. Registered index-linked annuities (also called RILAs), are a type of VA that credits annuitants with a higher percentage of the underlying investment’s gains while providing a lesser degree of downside protection. Both are likely to increase the percentage of gains that can be credited to the account.
“Higher interest rates are going to make annuities more attractive on an absolute basis,” says David Blanchett, the Lexington, Ky.-based head of retirement research at PGIM, the investment management group of Prudential. “That’s pretty unequivocal.”
Relative Attractiveness
But income-producing annuities are relatively more attractive when interest rates are lower, Blanchett says, “because annuities provide the benefits of longevity pooling.”
Longevity pooling refers to the mortality credits that tend to favor younger annuity holders. Annuity payout rates are only partly linked to interest rates; they are also calculated using the age of each annuitant relative to other annuitants. Those who live longer end up receiving a higher yield—i.e., more lifetime income.
“Rising interest rates are the proverbial high tide that lifts all ships, improving all fixed-rate products,” says Kalem Mackey, executive vice president of insurance distribution at C2P Enterprises in Westlake, Ohio. But only income annuities, he adds, offer mortality credits.
“On a relative basis,” says Wade Pfau, Dallas-based author of the Retirement Planning Guidebook and co-founder of the Retirement Income Style Awareness assessment tool, “lifetime income provisions from annuities are more attractive when interest rates are low.”
Annuity Providers Have More Capital
Still, there’s no denying that annuities look noticeably more appealing right now. When interest rates move up, annuity providers have more capital on hand and can become more generous. That’s “a good thing for the industry,” says Brian Sward, executive vice president and head of product solutions at Franklin, Tenn.-based Jackson National Life Distributors, a unit of Jackson National Life Insurance Co.
Scott Gaul, head of individual retirement strategies at Newark, N.J.-based Prudential, agrees. “As rates rise, financial services companies like Prudential are often able to enhance value for customers,” he says, adding that annuities have advantages regardless of interest rates. Tax-deferred growth, for instance, is a benefit “no matter what the economic environment,” he says.
Indeed, annuities are “a powerful tool for most people, given their unique ability to provide accumulation and/or income-for-life guarantees,” says Dave Hanzlik, vice president for annuity and retirement solutions at CUNA Mutual Group in Madison, Wis. “Interest-rate environments do not change these fundamental benefits.”
The Annuity Decision
There’s little question that the decision to buy an annuity “can depend on the broader market environment, along with other factors, including an individual’s personal retirement goals,” says Corey Walther, president of Allianz Life Financial Services in Minneapolis. Risk-averse individuals, in particular, can find these vehicles appealing.
Jared Nepa, vice president and national sales manager for annuities at Lincoln Financial Group in Radnor, Pa., strikes a similar chord. “Interest rates may affect the rates for certain annuity categories, but they have minor impact on the protection [annuities] can provide to an investor’s account value or income in retirement,” he says.
In other words, if they are right for a particular client, interest rates shouldn’t matter. “Annuities in general may be attractive to clients seeking specific benefits,” says David Porro, director of insurance at Summit Risk Management in Parsippany, N.J. “Higher interest rates may only magnify the impact of these benefits.”
Caveats
To be sure, some experts point out that annuities “are not investments but risk management tools,” as Richard Anzelone, a partner at StrategicPoint Investment Advisors in Providence, R.I., puts it.
Karl Wagner III, a partner and senior wealth advisor at Biondo Investment Advisors in Milford, Pa., says annuities are “simply a function of transferring risk. As rates rise, certain investments pose less risk and others more.”
Annuities also often have “surrender charges,” or fees for taking money out too soon. They may tie up funds for “three to seven or more years [and] that can make gaining access to your money extremely expensive,” cautions Robert Steinberg, founder and CEO of Blue Chip Partners in Farmington Hills, Mich.
Nevertheless, people likely will keep flocking to annuities this year to lock in the high payout rates. “Rates today represent an opportunity to buy lifetime income at a lower price than we’ve seen in over a decade,” says Michael Finke, professor of wealth management at the American College of Financial Services in King of Prussia Pa.