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David Blanchett

Retirement Planning > Retirement Investing > Annuity Investing

Bonds May Be Down, But Some Annuity Payouts Are Up

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What You Need to Know

  • Annuity payouts can be affected by bond yields and therefore as interest rates have increased, so has the payout rate for a variety of annuity strategies.
  • Quotes from annuity providers show the spread between the best and worst payout have increased notably as interest rates have risen.
  • It’s important to ensure the annuity product or strategy is competitive given the widening dispersion in payout rates among products.

It’s been a pretty wild ride for the markets in 2022. Equities and bonds are down so far for the year, and inflation is up (way up on a relative historical basis) — creating a challenging environment for investors.

I’ve spoken with quite a few investors and financial advisors over the last few years and a common hesitancy to purchasing an annuity has been the relatively low bond yield environment.

Annuity payouts, especially those with relatively long durations (think younger annuitants) can be significantly impacted by bond yields. Thus, as interest rates have increased, so too has the payout rate for a variety of annuity strategies.

While it will take some time for some of the more complex products to have more attractive payouts (think strategies with a protected or guaranteed lifetime income benefit), annuities that have simpler payout structures, such as immediate annuities (if you want income) and fixed rate annuities (or multi-year guaranteed annuities, MYGAs, if you are focused on a guaranteed return) are going to be more rate responsive and likely to have payouts that have increased recently.

One thing I have noticed, though, looking at actual quotes from various annuity providers, is the spread between the best and worst payout have increased notably as interest rates have increased.

In other words, certain providers are being more responsive to the interest rate increase than others.

How It Works

For example, I obtained payout rates for a life-only immediate annuity for a 65-year-old male from CANNEX on May 12. The highest payout rate was 6.563% for a $100,000 premium (i.e., it would generate $6,563 per year for life) while the lowest payout rate was 5.383%.

This is a difference of roughly 22%, which is especially notable and wider spread than what I’m used to seeing, which has been closer to 10% historically.

Additionally, the insurance company with the highest payout rate also has an AM Best financial strength rating that is higher than the company offering the lowest quote.

While there are obviously other considerations when assessing the quality of different annuities, a higher payout and a higher financial strength rating is a pretty powerful combination and suggests a “free lunch” potentially exists for advisors and retirees who are able to shop around for the most attractive rates.

Higher interest rates also create interesting dynamics for strategies like delayed claiming of Social Security retirement benefits. While delaying claiming Social Security retirement benefits is a smart move for most retirees, the benefits of delayed claiming effectively decline as interest rates increase because Social Security retirement benefits are effectively agnostic to the market environment.

Higher or lower interest rates don’t really affect Social Security retirement benefits but they do affect your alternative choices (e.g., investing or purchasing an annuity).

Social Security retirement benefits have a number of attractive attributes (tax favored, linked to inflation, survivor benefits, etc.) that make them the first place retirees should look for income, but the value of doing so is going to evolve as interest rates do.

While it’s not clear where interest rates are headed, the recent increase in rates should cause advisors and retirees to at least reconsider the role of annuities as part of a retirement income or investment strategy.

When considering annuities, it’s also become more important to ensure the product or strategy is competitive given the widening dispersion in payout rates among products available today.

David Blanchett is managing director and head of retirement research for PGIM DC solutions, an adjunct professor of wealth management at The American College of Financial Services, and a research fellow for the Retirement Income Institute.


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