From the September 2009 issue of Boomer Market Advisor • Subscribe!

September 1, 2009

This may interest you

With short-term Treasury rates currently at Japanese-style lows, investors and advisors often ask annuity cheerleaders like myself if they would be wise to delay purchasing an income annuity until interest rates--and annuity payout rates--are higher.

My short answer: That's a market-timing question. You might as well ask, "Should my clients cash out at the apex of a bull market?" Of course they should. But no one knows when that happy day will arrive.

There's a longer answer, however, and it has three parts.

First, the interest rates that matter here aren't necessarily at historic lows. It's true that, at .25 percent, the Fed Funds rate--the rate for overnight loans between banks--is the lowest since the 1958 recession. But insurers don't use the Fed Funds rate to price income annuities.

Instead, insurers base their payout rates on corporate rates. From 1919 to 2008, the average rate for long-term AAA corporate bonds was 6 percent. Today, the rate is close to 6 percent and well above the lows of 2.5 percent in the late 1940s. Moshe Milevsky of York University told RIJ, "I think that 'real' interest rates are relatively high, and that an inflation-linked annuity would make sense, especially now, when inflation fears are low and protection is cheap."

Second, fear of higher rates assumes that inflation is coming. And that's not a certainty. Goldbugs warn that massive federal borrowing will force the government to offer higher rates. But it's equally likely that economic stagnation will cause the Fed to suppress rates for a long time. Fed chairman Ben Bernanke said as much on July 21.

Hersh Stern, who runs immediateannuity.com, doesn't think the economy is on the verge of a boom. Long-term Treasury rates, which are driven by the economists who read the tea leaves at the Bank of China, are still the best leading indicator of inflation, he says. At 4.43 percent, those rates don't foretell inflation to him.

Third, interest rates are only one component of annuity payouts. Distributions of principal contribute to the stream. So do mortality credits--the dividends that accrue to surviving contract owners as the original pool of owners contracts. Mortality credits account for a growing share of the payment as you delay the start date.

"For older annuitants, the value of the mortality credits will likely dwarf any losses due to rising interest rates," says Lowell Aronoff of Cannex, a provider of income annuity data in Toronto. Maybe your client should postpone an annuity--but for a bigger mortality credit, not a higher interest rate.

Debates about the timing of an income annuity purchase miss the point, however. An income annuity isn't an investment; it's a hedge against running out of money. In practical terms, it's an efficient, low-risk way to spread retirement savings across 20 or 30 years. And it offers ordinary folks the same quality of sleep that defined benefit pensioners famously enjoy.

As bootlegger, diplomat, and presidential father Joe Kennedy, once said, "Only a fool holds out for top dollar."

Kerry Pechter is the author of "Annuities for Dummies" and editor of retirementincomejournal.com.

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