Annuity Interest Rates: How it affects pricing
The Annuity Man
Since the Fed has recently lowered rates again, and the U.S. 10 Year Treasury note seems to be headed to zero (or worse)...the majority of questions I get are about annuity interest rates. People always want to know how it affects annuity pricing, and the ridiculous request on how they can try to “time it.” Spoiler alert...you can’t!
As with anything annuity, the answers to these questions are not black and white. So the question “What is the best annuity rate?” can NOT be answered unless you specify what type of annuity you are talking about and what you are trying to contractually achieve. It would be like asking “What is the best restaurant?” without knowing what type of food you prefer.
Without getting into the weeds, let’s take an easy to understand look at how rates affect the pricing of specific annuity types.
Annuities, regardless of type, are guaranteed insurance contracts offered by life insurance companies. When it comes to annuities that guarantee a lifetime income, the primary pricing mechanism is your life expectancy at the time you start the payments. Actual interest rates play a secondary role. With that being said, if interest rates were higher...it would help with pricing even though life expectancy drives the train.
Single Premium Immediate Annuities (SPIAs), Deferred Income Annuities (DIAs), Qualified Longevity Annuity Contracts (QLACs), and Income Riders attached to some deferred annuities (like Variable and Indexed) all primarily base their lifetime income payments on life expectancies when the payments start. If you set up the payment stream for 2 lives (i.e. Joint Life), then it’s based on 2 life expectancies.
Annuities are the only product that pays a guarantee income stream for life. Pensions and Social Security also guarantees a lifetime income, and both of those are annuity structures as well.
So what is the “rate of return” or ROI (Return on Investment) on a lifetime income annuity. There’s no way to calculate that until you die. Up until that point, it is a pure transfer of risk strategy for a secure retirement income stream.
A common question I get is, “How much can you earn on a 100,000 annuity pay per month?” The answers I need to know are if you want to structure the payments “Single Life” or “Joint Life,” your date(s) of birth, and when do you want that income to start. From those responses, I can then provide a contractually guaranteed answer.
If your goal is to fully protect the principal (like a CD), then a Multi-Year Guarantee Annuity (MYGA) is your product. It’s the annuity industry’s version of a CD (Certificate of Deposit). In a non-IRA account, MYGA fixed rate interest grows tax deferred. With a CD in a non-IRA account, you have to pay taxes on that annual interest. That’s the primary difference between the two strategies. CD rates and MYGA rates can be efficiently used together with laddering strategies.
Fixed Index Annuities (FIAs) are also CD products and fully principal protected, but the returns are not guaranteed and attached to an index call option. FIAs are hyped as market return products, which is both misleading and fraudulent.
Annuities that offer a fixed rate or CD type return (i.e. MYGAs and FIAs) have a specific surrender period and surrender charges if you exit the policy before the contractual period of time. The guarantee period for the interest is decided by you, and can be as short as 2-3 year and as long as 10 or more.
Annuity interest rates with these types of principal protection products is based on both current rate levels and a competitive environment to attract premium. Life expectancy plays no pricing role.
Jimmy Carter Bonds
When annuity companies offer guaranteed rates with an insurance product, they are not just using current rates for pricing. Current levels do move the sentiment needle, but these carriers are looking at their overall fixed rate portfolio from a pricing standpoint. That might include some old high yielding Jimmy Carter era bonds as well as today's low rate offerings.
That specific interest rate offered and guaranteed is based on the overall holdings of the company and driven by a competitive and commoditized marketplace looking to attract premium. However, It’s a no-brainer that if current interest rates were higher, then overall annuity pricing would be better.
Even though life insurance companies (i.e. annuity carriers) are heavily regulated and hand-cuffed with what they can invest your money in, it’s still a competitive world to attract premiums (i.e. your money). Never forget that, and never allow an agent or advisor to just show you one carrier. Shop for annuity guarantees like you shop for a plane ticket.
Banks On The Same Street
Have you ever driven down the street and saw one bank on one side of the road offering a CD with a higher percentage guarantee than a bank on the other side with the same CD. That happens because one bank is trying to aggressively attract more money than the other. The CD product and term is the same, but the percentage is higher with one bank because they want you to deposit your money with them.
The same is true for pure fixed annuity rates (like MYGAs) or with an income annuity rate with SPIAs, DIAs, and QLACs. The products are the same, but the guarantees will be higher with some carriers because they want to attract your money.
This is the reason you have to shop as many carriers as possible to find the highest contractual guarantee for your specific situation. You have to use that competitive pricing environment to your contractual favor.
Claims Paying Ability
Regardless of the type of annuity contracts you are considering, annuity purchasers should always look at the financial strength of the issuing carrier. Whether it’s Variable Annuities (VAs), Fixed Index Annuities (FIAs), Single Premium Immediate Annuities (SPIAs), Deferred Income Annuities (DIAs), Multi-Year Guarantee Annuities (MYGAs), or Qualified Longevity Annuity Contracts (QLACs)...the guarantees offered are only as good as the carrier backing them up.
After shopping all carriers using an object annuity interest rates calculator for the highest contractual guarantee, then you need to dig down into the claims paying ability and ratings of the carriers. I recommend using the COMDEX Ranking system which is an easy to understand 1 to 100 score that uses all 4 ratings services (AM Best, Moody’s, S&P, Fitch) to calculate the score.
Annuity interest rates should play an important part in your retirement planning. There’s only 2 questions you have to ask and answer:
- What do you want the money to CONTRACTUALLY do?
- When do you want those CONTRACTUAL guarantees to start?
From those 2 answers, you can then determine the exact type of annuity that can provide the highest contractual guarantee and that can maximize annuity interest rates from a specific pricing standpoint.