At the end of the third quarter, the Secure Retirement Institute (SRI) calculated that total annuity sales fell 8% from the corresponding quarter a year ago. Todd Giesing, senior annuity research director at the Windsor, Conn.-based SRI, attributed the drop, in part, to low interest rates. “Interest rates impact all individual annuity products’ pricing,” he said, adding, “Low interest rates are likely to lower the amount of guaranteed income created by an annuity.”
Low interest rates are often used as a reason for avoiding annuities, but does it make sense to wait for higher interest rates before buying one of these products?
Hard To Predict
It’s impossible to predict when interest rates will change.
“Annuity payouts are definitely tied to interest rates,” says David Blanchett, senior education fellow with the Alliance for Lifetime Income and head of retirement research at Chicago-based Morningstar Investment Management. “So if interest rates rise, payouts are going to increase. The problem is we don’t know when, or if, this is going to happen.”
It’s like trying to time the market: impossible. “It is very difficult to predict when [interest rates] might rise,” says Eric Henderson, president of Nationwide Annuity in Columbus, Ohio. “If an annuity is the right solution for a client at the current time, it is probably unwise to gamble on rates going up.”
Yet there’s another, even more compelling reason that waiting to buy an annuity may be misguided.
Mortality Pooling
It has to do with the way annuity payouts are calculated. Generally, the payout amounts are based on not just interest rates but also on “mortality credits” or “mortality pooling.” Those are actuarial terms that basically relate to your life expectancy at the time you buy an annuity. Older annuitants, who are more likely to die sooner, help fund the payouts to younger annuitants.
Or, to put it another way, the older clients are when they buy an annuity—i.e., the longer they wait—the lower their payout rate will likely be. “Waiting is going to ‘cost’ you,” says Blanchett.
It’s also a matter of relative value. When interest rates are low, bonds—the other traditional sources of retirement income—aren’t very appealing. One can argue it makes more sense to buy an annuity now simply because it’s so hard to get a reasonable income level any other way.
Relative Value
“The relative value of an annuity actually rises the lower interest rates go,” Blanchett explains. “Interest rates are going to affect all investments, but you only get mortality pooling when you annuitize. [You don’t get it from buying bonds or any other instruments.] Lower interest rates have reduced both the returns on bonds and the expected payouts on annuities, but the mortality pooling aspect hasn’t really changed at all. That means you’re going to be able to generate more income from an annuity today, relatively speaking, than from a bond portfolio.”
Tim Seifert, senior vice president and head of annuity sales at Radnor, Pa.-based Lincoln Financial Group, a big annuity provider, gives an example: Lincoln’s income rate for a 65-year-old annuity holder today is 4.75%, and the current yield on a 10-year Treasury bond is only about 0.75%. That’s a difference—a spread—of 400 basis points. A year and a half ago, however, the same annuity was paying 5.75% while the Treasury was paying 3.25%, a difference of just 250 basis points. “The value proposition of the annuity … has arguably never been better,” he says.