Here’s How to Best Time Interest Rates When Purchasing an Annuity
January 3, 2017 by Stan Haithcock
Is there a way to perfectly time an annuity purchase when interest rates are rising?
With the Federal Reserve recently raising rates, the continuing conundrum of trying to time an annuity purchase is once again the center of most annuity buying decisions and agent sales pitches. Like most financial decisions, there are no perfect answers.
When uninformed and misleading pundits say “I hate annuities,” it is like saying that they hate all restaurants. One can’t legitimately categorize annuities in that broad of a brush stroke.
There are many types of annuities, and each one has different contractual benefits and limitations that need to be fully understood, especially when it comes to how rates affect the guarantees.
The annuity type that is 100% dependent on interest rates is the multi-year guarantee annuity. This is also referred to as a fixed-rate annuity, and the industry’s version of a certificate of deposit.
With an MYGA, an individual receives a guaranteed annual percentage growth for a specific period of time. The shortest duration, i.e. surrender charge time period, is three years.
The U.S. 10-Year Treasury rate is the so-called bogey to watch when it comes to all annuity types and the rate that annuity companies primarily use for pricing the products.
Annuities were introduced as a pension payment for Roman soldiers and their families and are still primarily used for lifetime income guarantees.
Retirement guru Tom Hegna calls the benefit of never outliving one’s money the “secret sauce.”
No other financial product on the planet contractually solves for longevity risk, and this is the unique benefit proposition that only income strategy annuity types offer.
Deferred-income annuities, income rider attached benefit guarantees, qualified longevity annuity contracts and single premium immediate annuities all deliver the secret sauce of transferring risk for lifetime income.
Because people have been trained as investors to always fixate on rates, it is a logical thought progression, albeit incorrect, for annuity buyers to obsess about how rates affect annuities. The contractual truth is that life expectancy is the driving force for lifetime income calculations, with rates playing a secondary role.
Common sense says that when rates are higher, annuity pricing will benefit. However, buying a DIA, income rider, QLAC or SPIA is a bet between an individual and the annuity company on how long that person will live.
Regardless of one’s life outcome, the annuity carrier is on the hook to pay.
The only way to effectively try to time an annuity purchase and hopefully maximize rates is to ladder the purchase over time. Most people are familiar with laddering bonds or CDs, so annuity laddering works in the same manner.
For lifetime income guarantees, one can ladder an annuity purchase over time and can also ladder the start date of the income stream. Splitting up the purchase date over time is the only rational strategy to potentially time rates.
Even being this pragmatic is no guarantee that an individual will nail it, because none of us know what future rate levels will be.
With MYGAs, because they function similar to CDs, one can ladder the maturity dates so as to have money coming due free of surrender charges to hopefully lock in higher rates at that time.
Annuity companies sit around the big marble table every day discussing the same rate timing questions consumers predictably ask and try to figure out how to price the products so that an individual will sign the application paperwork now.
Those who are looking for any type of annuity pricing arbitrage or buying signal are wasting their time. That is an annuity fact.
For example, those who are trying to time a SPIA purchase must figure in the payments that they miss while they are trying to throw that perfect rate dart to actually buy the SPIA. The same theory applies to DIAs, income riders or QLACs where the income starts at a specific time in the future.
It is important to understand that the longer an individual allows the annuity carrier to hold on to the money, the more that it will enhance the payout when he or she decides to start the income stream. Holding off on locking in that future income guarantee to time rates will most likely produce a lower income guarantee because the money wasn’t allowed to “cook” as long with the carrier.
Annuity companies don’t make these decisions black and white or at all easy for consumers.
If the contractual guarantee of the specific annuity being considering achieves an individual’s goal, then it might make sense to move forward with that plan. That is as simple as it gets.
