First the bad news: Annuity payouts started heading south last year and will continue to do so this year – as much as 10 percent – because insurance companies are adopting new mortality tables that show people are living longer, requiring insurers to offer guaranteed lifetime payments for additional years.
Now the good news: There is a credible chance that some or all of these cuts will be reversed later this year if Federal Reserve-engineered increases in short-term interest rates translate into increases in long-term interest rates, which is usually the case. This would prod insurance companies, flush with higher profits from the bonds in which they invest, to increase payouts to offset sluggish sales.
What to do in the interim: Don’t wait to buy annuities, which, among other things, pay considerably more interest than bank CDs and are virtually as safe. Rather, consider building a ladder of fixed annuities with different maturity rates, offering respectable income while the ladder hedges, in part, against the risk of rising rates.
Why Mortality Tables Are Changing
As recently reported in Annuity FYI, new mortality tables show that 65-year-old men, for example, are living three years longer than they did in 2000 and 65-year-old women more than two years longer. Insurance companies must adjust to this to make profits. Annuity payouts have already been declining for years, largely because of a sharp drop in interest rates. Mortality table-induced adjustments last year and this year, however, will mark the deepest and most widespread cuts since 2008.
But if these cuts had to come, at least they’re coming at the right time. There was almost no hope of rising annuity payouts before the Federal Reserve increased interest rates last month because there was no way insurance companies could earn more money on their bond investments — a necessity to feel comfortable about increasing annuity payouts. They still may not earn more money. But the odds are good, with a lag, market observers say, and that could offer relief against mortality table-related payout cuts.
There is the inevitable delay to consider, of course. That is where fixed annuities – specifically, the Multi-Year Guarantee Annuity (MYGA), come into the picture. In addition to paying more than CDs – generally 2 percent to 3.25 percent annually for three to 10 years – taxes on the interest are deferred until withdrawal in a non-IRA account, allowing the annual yield to compound and grow more.
The Creation of a Ladder of MYGAs
Most important, in today’s environment, is the creation of a ladder of MYGAs, many financial planners say. Instead of putting all your money in one 10-year MYGA, for example, you could slice that money as you would a pie and put equal amounts in, say, a three-year, five-year and seven-year MYGA, which, at current rates, pay 2 percent, 2.65 percent to 2.8 percent, and 3 percent respectively if you want the option to withdraw 10 percent of your principal without penalty starting in the second year. This provides a partial hedge against the uncertain timing of rising interest rates. If, say, rates rise after three years, you have collected your money from your three-year MYGA and can transfer it to another, now higher-paying MYGA – and as a non-taxable event.
In short, you fare better if rates rise and aren’t hurt if they do not. “A basket of fixed annuities allows you to preserve flexibility and benefit from higher rates down the road,” says Scott Sadar, an executive vice president at Somerset Wealth Strategies. “The Federal Reserve is just starting to raise interest rates. A lot of people want to wait and see how much higher the Fed will raise them.”
For those who need more current income, perhaps because they are at least 70 years old and have to pay Internal Revenue Service’s Required Minimum Distribution (RMD) on their IRAs and 401 (k) plans, the best route today may be a seven-year MYGA. After one year, those paying 3 percent annually allow the withdrawal of 10 percent of principal annually.
Down the road, insurance companies are looking for an excuse to improve annuity payouts, says Andrew Murdoch, the president of Somerset Wealth Strategies. That’s because dwindling annuity payouts — which had been falling well before the adoption of new mortality tables, mostly because of ultra-low interest rates – have hurt sales. In the first nine months of 2015, the latest figure available, total annuity sales totaled $169.6 billion, down 2 percent from the same period in 2014, according to the Insured Retirement Institute.
Annuity Sales Much Better in the Past
In healthy years in the past, such as 2006 and 2007, annual sales, spurred by more generous benefits and generally lower fees, rose 10.3 percent and 8 percent respectively. “Insurance companies would love to see those kinds of gains again,” Murdoch says.
Prospective annuity owners should also weigh their investment options outside the annuity world, say Murdoch and other financial planners. The stock market, in particular, has been stumbling for a year and so far in 2016 looks downright scary. Moreover, many experts believe future long-term stock market returns will be a more modest 6 to 8 percent annually, down from an historical annual average of 10 percent, giving stocks a less compelling edge over other investments.
Like any company selling anything, insurance companies have to offer good value to thrive. Some huge annuity vendors, such as Nationwide and Guggenheim, have already begun to improve terms on select annuities. As interest rates start climbing, watch for them and many others to roll out still more attractive annuities. The mortality table issue won’t disappear, of course, but it will become more palatable.
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