If you’re close to making the decision to buy an annuity, here is an important heads-up. You’re better off buying the annuity before year’s end because income payouts in 2016 are headed downward – courtesy of the adoption of new mortality tables that once again show people are living longer.
According to the Society of Actuaries, the typical annuity next year is likely to make payments that are about 10 percent lower than the same annuity purchased this year.
Annuities commonly change living benefit payments, which have been trending downward for years in the aftermath of the Great Recession, partly because of a sharp decline in interest rates. The payout adjustments on the horizon, however, will mark the deepest and most widespread cut in payments since 2008-2009, annuity experts say. Insurance companies have to cut payouts to maintain profitability in light of the latest dose of reality underscoring that guaranteed lifetime payments will last longer than ever.
The Society of Actuaries periodically updates mortality tables, mostly for use by insurance companies that sell annuities and by pension plans. The latest review of annuity mortality tables, in 2012, was implemented with a lag in 2015 in 34 states, including the five biggest by population – California, Texas, Florida, New York and Illinois.
These states and the 16 others, as well as the District of Columbia, are expected to react by cutting benefit payouts on new annuities early in the new year. In doing so, they will reserve more money in anticipation of future payouts, for which they will get tax breaks
“If you’re on the fence about buying an annuity, now is an opportune time to lock in benefits and be rewarded with a lifetime of higher income,” says Andrew Murdoch, the president of Somerset Wealth Strategies.
2012 marked the third time since 1983 that the Society of Actuaries changed its nearly universally followed mortality tables, which is a set of survival probabilities that describe how likely an individual is to live to a certain age, broken out by gender. The latest mortality tables, just like the predecessor tables, showed that people continue to live longer. In the 1983 mortality tables, for example, men on average lived 83.6 years. That grew to 85.4 years in 2000 and to 88.5 years in 2012. Women on average lived to 87 in the 1983 tables, increasing to 88 years in the 2000 tables and to 90.3 years in the 2012 mortality tables.
In addition, a 65-year-old couple can expect at least one spouse to live to age 94.7, compared to 90.6 in 1983.
Insurance companies are waiting until 2016 to trim payout rates partly because they want to do it simultaneously in all states in which they business, avoiding the administrative complexity and possible confusion among consumers of using one mortality table in some states and a different table in others. “It’s easier for insurance companies if they make their changes in lockstep,” Murdoch says.
He and other financial planners believe that annuity payouts may eventually rise now that the Federal Reserve last week increased interest rates for the first time in nine years. There isn’t a direct correlation between the direction of short-term interest rates, which the Fed controls, and long-term rates on mortgages and bonds, which it does not. This could easily change, however, in a rising inflationary environment. In this case, if insurance companies earn more on investments in bonds, that could set the stage for more generous lifetime annuity payments and partly offset mortality table-based cuts in income payouts. But before this scenario plays out – assuming it does – several Federal Reserve interest rate boosts, not just one, would have to occur, Murdoch says.
Murdoch says the looming cuts in annuity living benefits will not have significant impact on annuity sales because annuity payments will remain markedly higher than bank CD rates and probably bond rates. “People look at annuities as a part of the investment landscape,” Murdoch says. “They don’t look at them in a vacuum.”
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