In March, the Federal Reserve is expected to raise interest
rates for the first time in four years. For anyone considering buying an
annuity or other income-oriented vehicles, that should be good news.
“Rising rates could have a very positive impact on annuities
and the benefits they provide,” says Tim Rembowski, a vice president at DPL
Financial Partners in Louisville, Ky.
But which annuities, and exactly how they will be impacted,
Fixed annuities, which are insurance contracts that pay out
a specific, guaranteed rate, are most directly affected by interest rates. As
rates rise, “investors can get a better payout for the same premium,” says
Philip Chao, principal at Experiential Wealth in Cabin John, Md.
Fixed-indexed annuities (FIAs), though, pay out a rate based
on the performance of a market index, such as the S&P 500. Holders of these
contracts benefit when the index rises, and there is usually a limit on losses
if the index falls.
But the amount of index gain that’s credited to the FIA can
fluctuate. If the insurance company’s general account grows, the company can
offer a higher cap rate, which is the percentage of index gains that are
credited to the FIAs. And insurance companies’ general accounts are expected to
grow as interest rates rise. “Shoring up the balance sheet enables insurers to
offer more attractive annuities,” says Karl Wagner III, a partner at Biondo
Investment Advisors in Milford, Pa.
That’s true no matter what type of annuity you’re talking
about. Eric Henderson, president of Nationwide Annuity in Columbus, Ohio, puts
it this way: “Rising interest rates allow us to offer increasingly competitive
At Lincoln Financial Group, the annuity provider
headquartered in Radnor, Pa., chief investment officer Jayson Bronchetti adds,
“The new money yields of our investment portfolio also increase, which is a
positive contributor within the overall annuity rate-setting process.”
Also expect these higher crediting rates on registered
index-linked annuities (RILAs), an increasingly popular type of variable
annuity (VA) that uses a stock index to determine gains and losses.
In general, variable annuities are more closely pinned to
equity markets. Traditional VAs—not the RILA variety—hold contract assets in
mutual-fund-like subaccounts. If equity markets slump with rising rates, their
performance will suffer, too.
“If you absolutely knew that stocks would have a loss, I
suppose a fixed annuity would be better [than a variable annuity],” says Wade
Pfau, director of the Retirement Income Certified Professional designation
program at the American College of Financial Services in King of Prussia, Pa.
But, he adds, that’s only true for VAs without a guaranteed living benefit
rider, which is an optional add-on that, for a fee, secures a separate income
“Rising interest rates will give insurance companies more
flexibility to increase payout rates on living benefits,” says Todd Giesing, an
assistant vice president at the Secure Retirement Institute in Windsor, Conn.
Predicting which way equity markets will go is impossible,
of course. “It sort of depends on whether the rise in bond yields is more or
less than the anticipated rise in bond yields that’s already priced in,” says
Joe Tomlinson, an actuary and financial planner currently based in West
Annuities Versus Bonds
To be sure, a rise in interest rates will cause an increase
in most newly issued bond yields (as well as savings accounts, money market
accounts and CDs). Relatively speaking, how will annuities stack up?
This current increasing interest-rate cycle is still in its
early innings. “The rising tide of higher rates lifts all interest-bearing
boats,” says Frank O’Connor, a vice president at the Insured Retirement
Institute in Washington, D.C.
But rising bond yields means bond prices will fall, hurting
most bond funds, at least in the short run. “This could positively impact
annuities,” says Pete Golden, chief sales and distribution officer at Equitable
in New York City.
Moreover, annuities can provide benefits that bonds don’t,
such as guaranteed income for life—“one of the main reasons financial
professionals bring annuities to their clients,” says Bryan Pinsky, a president
at AIG Life & Retirement in Woodland Hills, Calif.
“This ability to guarantee a lifetime stream of income,
which bonds cannot do, is what makes annuities appealing to retirees worried
about outliving their savings,” adds Andrew Melnyk, chief economist at the
American Council of Life Insurers in Washington, D.C.
Besides guaranteed lifetime income, some annuities offer
other add-ons—such as long-term-care insurance and death benefits. “The
different types of contracts offer different benefits that bonds cannot,” says
Michael Zmistowski at Financial Planning Advisors in Tampa, Fla.
In the new interest rate environment, annuity providers will
no doubt keep innovating. “We need to see what new annuity products the
insurance companies come up with,” observes Brett Bernstein, CEO and co-founder
of XML Financial Group in Rockville, Md.
Annuities have another advantage over bonds: Their payout
rates aren’t based entirely on interest rates but also on mortality credits.
Sometimes called mortality pooling, this is an actuarial calculation that
weighs each annuitant’s life expectancy at the time of purchase.
“Annuities offer an income advantage over the bond alone for
anyone over 70, through mortality credits,” says Jason Branning at Branning
Wealth Management in Ridgeland, Miss.
It’s All In The Timing
Whatever happens, existing fixed annuities won’t change.
Only newly issued contracts can reflect higher rates. “Because fixed annuities
are contractual obligations with a life insurance company, their value doesn’t
fluctuate,” says Kimberly Foss, president of Empyrion Wealth Management in
Don’t expect other types of annuities to change too soon
either. “It might take some time for the adjustments in [interest] rates to
make their way into payout rates,” says James Regan, a partner at SharpePoint
Annuity modifications will depend partly on how much and how
quickly the Fed moves. “The pace of change is critical,” says Russell Hill,
chairman of Halbert Hargrove in Long Beach, Calif.
Everything Is Relative
As of this writing, the Fed has announced a gradual tapering
of bond purchases in concert with rate increases. “So far, the rise in rates is
slight, not impacting products much yet and still way below what we have seen
even in recent years,” says Larry Rybka, president and CEO of Valmark Financial
Group in Akron, Ohio.
His colleague, Jacob Soinski, senior financial planner at
Valmark, adds, “An investor in bond funds will generally experience some return
lag in a rising interest rate environment, because newly issued bonds with
higher rates will be more expensive than the fund’s existing bond holdings.”
That’s also good for annuities. “Annuities can often provide
a greater benefit for long-term investors than buying bonds,” says Mike Harris,
a senior education advisor at the Washington, D.C.-based Alliance for Lifetime
Impossible To Predict
But one can never be sure how far the Fed will move. “It’s
not all that clear how comfortable Federal Reserve chair Jerome Powell is with
enacting less accommodative monetary policy,” says Joan Alexandre, an analyst
at Kestra Financial in Austin, Texas.
David Blanchett, Lexington, Ky.-based head of retirement
research at PGIM, the investment management group of Prudential, is similarly
cautious. “There’s a very real possibility rates could fall again,” he says,
“if we have a big negative market event.”
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