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Laddering Fixed Annuities Protects Against Interest Rate Risk

This year looks to be an interesting one for the annuity industry. There is quite a mix of different factors effecting everything from payouts to commission structures. In a recent article for Marketwatch titled “How to buy annuities in a dicey year,” Andrew Murdoch explains his recommended annuity strategy for this tumultuous year. One of the main things effecting annuities this year is the updating of longevity tables. This could reduce payouts by up to 10%. But on the flip side of that, payout rates could eventually increase with the steadily increasing interest rate levels. It will take a little longer for these interest rate increase effects to be seen though. For these and many other reasons, some consumers are questioning what they should do about purchasing an annuity. If you have already determined that an annuity product works best in your financial plan, it doesn’t make sense to turn to another source of income because there really is no better alternative to meet your retirement income needs.

Murdoch advises laddering fixed annuities over different time frames. He suggests purchasing MYGAs (multi-year guarantee annuity) because of their income payouts and their partial protection against the risk of rising interest rates. Longevity table changes won’t effect your MYGA payouts either. They typically pay 2%-3.3% per year and give you the option to withdraw up to 15% of your principal free of penalties. Your interest is also tax-deferred. Annuity ladders help you protect against interest rate risk. One example would be to purchase a 3-year, 5-year and 7-year MYGA with equal amounts of money. This spreads out your interest rate risk and frees up your money should interest rates be significantly higher when your contracts expire. If that is the case, you can then purchase a lifetime income annuity at the higher rates. In the mean time, your allowed withdrawals should meet your current annuity income needs.

Updated longevity tables have shown that people are living 2-3 years longer than they were at the last update in 2000. This means that insurance companies have to pay out income longer to those clients of theirs with lifetime income payouts. They’ve had to lower payouts in order to remain profitable. In an interesting twist, the Fed has increased short-term interest rates for the first time in nine years and plans to continue their increases throughout 2016. Although insurance companies base payouts on long-term interest rates, they typically follow the trend of short-term rates in due time. Insurance companies don’t want to lower their payouts because they want to offer attractive annuities and sell more products. But they have to offer payouts that make sense for their financials. If long-term interest rates increase, it could help make up for the updated mortality tables.

Annuity sales were down 2% from the first three quarters of 2014 through the first three quarters of 2015. Sales should be increasing in conjunction with an influx of retiring Baby Boomers, but lower interest rates and payouts have kept some annuity buyers away. Mr. Murdoch recommends purchasing an annuity ladder of MYGAs to receive a payout rate that offers considerable value until interest rates increase more. Annuities still make sense in comparison to the other investment options out there. The stock market was nearly flat last year and is off to a bad start in 2016. Some experts predict that stock market returns will be 20-40% lower than their historical averages going forward. Insurance companies will raise payout rates as much as they can to attract annuity buyers. Some have already introduced new and improved products despite the updated mortality tables. While the mortality table changes are here to stay, they will become less important as time moves on and won’t effect payouts nearly as much. Laddering fixed annuities is one way to protect yourself in a year when the annuity market is being effected by many outside sources.

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