Watching for interest rates to increase could cost retirees guaranteed income over time
by John Williams
Mr. Williams is the Regional Sales Director, Individual Annuities at The Standard. With 24 years of industry experience, he is involved in product development, sales management and competitive positioning.During times of economic uncertainty, it’s common for people to be concerned about their retirement, and how options like deferred annuities can fit in. After a record year for low interest rates, there may be indecision about purchasing a fixed annuity now, or waiting until rates increase. Even in a low interest-rate environment, an annuity can be a good choice for clients. Of course, the higher the rate, the better. However, rates have been low for quite some time, and retirees may be missing the opportunity to increase their savings by waiting for a higher interest rate.
A fixed annuity’s interest rate is the primary comparison against other financial products. Though a higher interest rate is always preferred, as we’ve seen predominantly since 2008, interest rates have been relatively low, often for a prolonged length of time. In 2020, the pandemic affected that. The current five-year guaranteed fixed annuity rate offered by a highly rated carrier is 2.50%, whereas in 2006 we saw rates as high as 6% guaranteed for six years. This goes to show that interest rates are relative— truly dependent in that specific moment of time.
While it’s worth noting that because fixed annuities are guaranteed for a certain amount of time, once an interest rate is locked in, interest rate increases or decreases will not impact the guaranteed rate during the duration selected. Personalized investment timeframes will determine whether that equates to 3, 5 or 7 years, and the interest rate changes slightly based on the duration.
Compounded Growth, Tax Deferral Grow Faster Than You Think
But even in a lower interest rate environment, compounded growth and tax deferral can grow savings faster than clients may think. To illustrate, if someone puts $50,000 into a five-year guaranteed annuity paying 2.05%, that person would be guaranteed $55,339 at the end of five years, minus any withdrawals taken.
By waiting one year before buying an annuity, that $50,000 would have to earn 2.57% annually for four years to catch up with the older annuity’s value of $55,339. And by waiting two years before buying the annuity, that $50,000 would have to earn 3.44% annually for three years to achieve the guaranteed $55,339. Example calculations like these can help demonstrate to clients that while interest rates are a determining factor in growth, they should not be the only one.
For those approaching retirement, market turmoil in 2020 may have impacted decision-making. While it’s normal for people to want the best return, they will only continue to miss out on growing their savings the longer they wait to decide. To help clients decide if purchasing an annuity is right for them, advisors can help by comparing annuity interest rates against risk tolerance, since not all financial investment options have the same associated risk.
This becomes important, as clients who consider fixed annuities do so specifically because they’re looking for safety and guarantees. No matter what the stock market does, clients will know exactly what to expect from their annuity by the end of their investment period. It is guaranteed. Similarly, because that money is placed with insurance companies, which are highly regulated, there is a higher level of safety and security around the investment.
Safe Money
Ultimately, fixed annuities are safe money products. Regardless of what the stock market may or may not do, their money is guaranteed for a fixed period of time of their choosing. Investing now means making the money work for the individual now. Rather than sitting in a checking or savings account, or another low-yield option, annuities will grow, even in a low-interest rate environment. Additionally, because of the tax deferrals associated with deferred annuities, clients do not have to pay income tax on the gain year-to-year compared to other investment options.
By talking to clients about their goals and how much money they want in the future, advisors can demonstrate how to reach those financial targets by investing now versus waiting. Rates have been low for quite some time and yet people have been, and still are, earning. While we continue to navigate the pandemic and the economy slowly begins to build back up, interest rates are likely to remain low. Providing clients a framework around how savings grow over time, along with the security of knowing their money is guaranteed, can alleviate retirees’ investment fears and encourage them to act today.
