Buying Annuities When Interest Rates Are Low
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Most of us think annuities were a much better deal when interest rates were a lot higher, as for example in the 1980s. But Professor Alicia Munnell of the Boston College School of Management thinks otherwise.
Prof. Munnell says an annuity is really worth more during times of lower interest rates. In this article we explore why Prof. Munnell favors annuities, and we look at two alternatives to annuities for generating retirement income.
Given continued stock market volatility and historically low interest rates, Prof. Munnell found that the portfolio would be depleted when the retiree reached age 83 (after 18 years), yet he still had a 54% chance of living past age 83!
This essentially provides a larger amount of guaranteed lifetime income payments for those who are still living - and more than any one single individual could have likely provided for himself or herself on their own. And yes, this is guaranteed income regardless of how low interest rates go.
In fact, based on Prof. Munnell's findings, a comparison of the alternative options shows that the gains from insurance company annuitization are substantial, even assuming that interest rates are at 0%.
To do this, insurance companies invest a large percentage of their assets in high-quality bonds. They choose these types of investments for their predictable stability. Since annuities are long-term contracts, their payouts correlate with long-term rates. As a result, annuity rates closely follow bonds with a duration of 20 or more years.
The benefit of certainty is a major reason people consider buying annuities. These insurance products can offer retirees a guaranteed stream of income. With a single premium immediate annuity, for example, you exchange a lump-sum amount for a monthly paycheck throughout retirement.
Essentially, annuity rates move with bond interest rates. Insurance companies pool together money and rely on some annuity holders dying early to help fund the guaranteed monthly incomes of others. But they also need to invest that money, too.
In 2003, a 65-year-old woman buying an annuity could expect to receive more than $600 a month. After 17 years of falling rates, a 65-year-old woman today can expect a monthly annuity payment of less than $450, a difference of about 25%.
Most important, annuities require you to tie up your money for a certain amount of time. Surrender charges are fees that are incurred when you withdraw money before a specified time period (surrender period) after you buy it, usually seven to nine years. Often, they start around 6-8%, but can be as high as 15%.
When rates are depressed, those interested in buying an annuity could wait until rates increase. But when you consider the long downward trend of interest rates, you have to wonder just when rates will rise to a level that is suitable for your specific income needs.
An annuity rate is a percentage by which an annuity grows each year. Annuity rates are determined by insurance companies. The annuity return rate depends on how much money is invested, interest rate and the length of the contract.
The guaranteed interest rates for traditional deferred fixed annuities and MYGAs make these two types of annuities easy to understand when it comes to interest rates and the return these products can provide over the course of the contract term.
Variable, income, and fixed index annuities are more complicated. Because their returns are not calculated according to a guaranteed stated interest rate for a set period, consumers will not find rates for these products when searching for the best annuity rates.
Annuity rates are tricky to compare because traditional fixed annuities guarantee an interest rate for a one-year term, whereas other fixed annuities guarantee rates for anywhere from three to 10 years. These multi-year term contracts are called multi-year guaranteed annuities (MYGAs).
The interest rates for indexed and variable annuities fluctuate with the stock market. Therefore, people who purchase one of these annuity types must review either the variable annuity prospectus or the strategy options and rate sheet for the specific indexed product they are buying.
Contracts with less generous withdrawal provisions may have higher rates. If you want the possibility of higher rates than fixed annuities offer and are willing to take on more risk, you could explore fixed indexed or variable annuities.
Historically high inflation pushed the Fed into making a series of interest-rate increases not seen in four decades. That, in turn, pushed bond rates higher. These higher bond rates prodded insurance companies that sell annuities to raise their monthly benefits.
Since payments offered by new fixed annuities track bond rates and bond rates track interest rates and inflation expectations, lower inflation could quickly lower payments promised by new fixed annuities.
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Single Premium or (Flexible or Scheduled) Installment Premium(When and How You Pay into the Annuity Fund)The premium is the money you pay an insurance company to buy an annuity contract. A single premium annuity means you pay the insurance company only one premium.An installment premium annuity is designed for a series of premiums.Many installment premium annuities are flexible premium contracts. This means you can pay as much as you wish, whenever you wish, within limits specified in the contract.Some installment premium annuities are scheduled premium contracts. This means the contract sets out the size and frequency of premiums you must pay. For example, you may pay $100 per month for the entire accumulation period.The accumulation period (also called the \"growth period\") is the time between when you start paying premiums and when you start receiving income payments. Many annuities end their growth periods when the person covered by the annuity reaches age 65, since this is when many people choose to retire.
An immediate annuity provides income payments that start shortly after you pay the premium. The accumulation period may be as little as one day.People who buy immediate annuities may do so because the money they put into an annuity will not be taxed until it is taken out, either through payment of benefits or withdrawal. This can defer tax payments until a time when their overall income is less and their tax rate may be lower. Immediate annuities are also generally purchased by people of retirement age. Immediate annuities are usually purchased with a single, lump-sum payment.A deferred annuity provides income payments that start later, often many years later.With a deferred annuity, you pay one or more premiums over the accumulation period. During this time, earnings build up (accumulate) on the premiums you pay. The premiums you pay and the interest earned goes into a fund called an \"accumulation fund\".The annuity payments you will receive begin at a future point in time called the \"maturity\" date. You will receive payments during a time period called the payout period, or annuitization period.Deferred annuities can be purchased with either a single premium or multiple premiums paid over a number of years.
The earnings of a variable annuity depend on the performance of the investment options you choose (for example, equity, bond, and money market mutual funds). A variable annuity may also offer the option of putting your money into a fixed account with guaranteed minimum interest. In times where investments are generally falling in value, this may offer you a more secure option. Otherwise, variable annuities have no guarantee that you will receive as much (or more) money as you have paid in, or that you will earn any interest on those funds.
Variable annuities generally do not provide that your contract will have any minimum value, other than a minimum guaranteed death benefit when death occurs during the accumulation period. Although your annuity contract will usually allow you to switch investment options, including the option of switching to a fixed annuity, if the investments that you have chosen do poorly, your annuity could be worth little or nothing.
The interest rate actually used by a company, usually referred to as the current interest rate (or \"declared\" interest rate), may be higher, but you should not assume that current rates will always be higher than the guaranteed interest rate.
How current interest rates are determined varies from company to company. Among the factors that a company considers are: the specific terms of the annuity contract you buy; the interest rate the company can earn on its investments; and, the expenses associated with administering and servicing the business.
You should ask to see the current interest rate for annuities that are in their second or higher year. This way you will know if you can expect the interest rate for the first year to be based on the same factors as the company will use in future years 781b155fdc