Annuities cast a light when things seem dim

By Jim Poolman

Several factors, including gross domestic product, unemployment and inflation, affect the strength of the U.S. economy. Although the economy is strong, the market has been experiencing the highest inflationary rates in 40 years.

Combating high inflation requires increasing interest rates, encouraging people and businesses to borrow and spend less. On Sept. 21, the Federal Reserve approved its third consecutive 75-basis-point hike, bringing current lending rates to a new range of 3%-3.25% — the highest they’ve been since the 2008 global financial crisis. Analysts predict interest rates will continue to 3.5% before the end of the year.

In theory, higher rates mean less spending, which translates to lower demand and should slow down price increases. But this could also lead to less economic activity. Rising rates and high inflation hit lower-income Americans the hardest as they face challenges purchasing necessities such as groceries and gas.

For retirees, it is a double-edged sword. While inflation diminishes a retiree’s purchasing power and increases lifestyle expenses, high rates on savings vehicles such as certificates of deposits or money market accounts mean they could potentially earn a little more.

Over time, however, inflation rates negatively impact how much retirement dollars can stretch. To combat this, individuals should consider products that help offset the cost of inflation. Annuities, for example, pay more as interest rates increase — casting a light when things seem grim. Rising rates may sound like music to the ears of investors debating whether to add an annuity to their retirement portfolios.

Interest rates and the annuity owner

In addition to being a safe accumulation vehicle, an annuity is also an income-generating product. Although there are different types of annuities, the good news is that interest rates determine their payouts. So, the higher the interest rate, the higher the annuity income payment.

Data shows that average immediate annuity payouts have increased by more than 11% for men and 13% for women since 2022. The trend appears even more pronounced with longevity annuities, a deferred annuity that starts paying income later in life. Payouts have jumped 42% for men and women since the start of the year.

A fixed indexed annuity protects principal from market loss and will never decline in value so long as the annuity owner continues to hold it through the length of their contract. However, annuities also generate income from interest. The annuity’s interest rate is based partly on changes in a market index, which measures how part of the market performs.

So as far as the economy goes, the higher the interest rate, the higher the annuity income payment. At the same time, the interest earning potential will never fall below zero, even if the index declines in value. This protects the product from inflation and helps generate higher income payouts at retirement.

How FIAs work

Generally, FIAs calculate index-linked interest in the following manner:

» A participation rate, which is the percentage of an index that is used to calculate interest crediting.

» And/or a cap, which is the maximum interest that will be credited.

» If the index loses money in any given year, the FIA does not lose money but rather will credit 0% (the interest rate floor).

Together, the interest rate floor, participation rate and cap determine the amount of interest someone earns. The interest earnings rate will always remain between the floor and the cap, and it will not rise above the cap, even if the index goes higher. Conversely, it will never fall below zero, even if the index declines in value. The value of the money will never decline due to market loss for as long as it is in the FIA, although it can increase with a rising index.

If your client withdraws their money from an FIA before an index term ends, the annuity may not add all the index-linked interest for that term to their account. Additionally, like many long-term financial products, such as certificates of deposit or mutual funds, FIAs have a surrender fee for early withdrawal, depending on the contract.

Market volatility and rising rates have created a perfect storm for investors looking for ways to protect their nest eggs and generate a guaranteed income stream in retirement. According to LIMRA, first-quarter FIA sales were up 21% this year compared to 2021, and LIMRA is predicting FIA sales will grow as much as 10% by the end of 2022. Currently, lifetime fixed-income annuity payouts are up 29%-30% from a year ago.

Retirement sentiments among Americans

Americans have never been confident about their retirement futures. Research conducted by the Indexed Annuity Leadership Council found that 42% of Americans say the pandemic has made them more risk-averse regarding their finances, and 76% of Americans say protecting their retirement nest egg from loss is important to them. Yet, as we face a potential recession, new research reveals that among those who have an annuity, 74% believe their savings and sources of income will last their lifetime, compared with only 43% for those without an annuity.
Americans do not want to outlive their income streams, and that suggests they are ready to embrace annuities and other retirement products that can provide lifetime income.

Things to consider when purchasing an FIA

When discussing the purchase of an FIA or any other type of annuity as part of your client’s retirement plan, start with three things:

1. Know your client’s financial goals and risk tolerance, how long they have before they retire, and what they will need their annuity payouts to fund. Understanding how and when they use their money will help them decide what to buy today.

2. Look into an insurer’s financial strength rating. The rating is critical because annuities are backed by insurance companies, not the federal government. The higher the rating, the more likely the insurer will be around to pay out your client’s annuity.

3. Know the roll-up rate (percentage at which the guaranteed side of the annuity keeps growing) and the payout rate (percentage of the annuity your client will receive) of an annuity. An insurance company’s portfolio of investments and profits may determine rates’ variations and can significantly vary between providers. Be sure to shop around to get the best quotes from different companies.

In addition to a steady, guaranteed and lifetime income stream with secured principal, FIAs offer predictable earnings and tax-deferred growth. Increasing interest rates present an opportunity to consider annuities as part of a diversified retirement portfolio. Other tactics to consider as you prepare your clients for inflation in retirement include rebalancing portfolios, pursuing alternative assets, liquidating assets to increase cash holdings, adding dividend-paying stocks to retirement portfolios and moving portfolios away from equities.

Retirement readiness shouldn’t be left to chance. And with the right amount of research and guidance, even uncertain times such as these can pave the way for thoughtful retirement planning.