Is Buying an Annuity in a Zero Interest Rate Environment a Good Idea?

The Federal Reserve’s decision to cut its benchmark federal
funds rate from 1% to a range of 0% raises significant questions for those
reassessing their retirement nest egg—a common occurrence following a dramatic
selloff in equities according to research conducted by Indiana University’s
Alessandro Previtero —and the value of annuities in providing guaranteed
lifetime income.

Historically low interest rates are often used as a reason
to avoid annuitizing at the present and forever locking in current interest
rates. The logic is that interest rates could increase in the future, which
would help support a higher subsequent payout rate from annuities if one waits.
This idea is worth a discussion, as it is not correct in the context of a full
retirement plan.

In addition, deferred annuities that use lifetime income
protections without immediately annuitizing the assets do not have this
problem. Even for the income annuity, which does lock in the current
environment at purchase, the case for its use becomes stronger in a low
interest rate environment for someone who is already retired and spending from
assets.

With low interest rates, the mortality credit or risk pooling component of the annuity payout becomes even more important, making annuities even more attractive relative to bonds. The bond interest component for spending is reduced for both tools as interest rates decrease, however annuities are hurt less by lowering interest rates, since the mortality credit component for spending is not impacted by interest rates.

Essentially, while the cost of funding retirement with an
annuity increases as interest rates decline, the cost of funding retirement in
other ways increases even faster than for the annuity. Therefore, the annuity
becomes a better relative deal.

As well, if we consider changing interest rates and their
associated risk, increasing interest rates would mean capital losses for bonds.
One could not simply sell bonds for their earlier value to take advantage of
the higher annuity rates. While waiting for rates to rise, if that happens, the
retiree will be spending their principal when spending exceeds interest and
dividends. The likelihood of needing to dip into the principal increases.

Even if rates do rise, retirees may not be able to purchase
more income as they are multiplying a higher rate by a smaller pool of assets
at this stage. If interest rates do not rise, bonds do not have capital losses,
but the annuity payout rates do not increase. The bottom-line? Waiting entails
risk. For retirees investing conservatively like the insurance company, it is
likely that one burns through assets fast enough to not benefit from any
possible future increased annuity payout rate. Retirees also give up some
mortality credits by waiting.

In conclusion, for those who still have the potential to
fund their goals in spite of recent market losses, and especially for those who
are panicking and thinking to sell their stocks and leave their funds in cash,
an annuity can still provide a way to lock-in a successful retirement income
plan no matter what else the future may bring.

 


Originally posted at https://retirementresearcher.com/is-buying-an-annuity-in-a-zero-interest-rate-environment-a-good-idea/

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