The Truth About Declining Annuity PayoutsBy Andrew Murdoch, CFP
Sadly, bad news has emerged on the annuity front — and brokers and agents should inform their clients and prospective clients accordingly and help them cope. Annuity payouts have been declining, typically about 10 percent, and those insurance companies that have yet to trim payouts are highly likely to do so as the year progresses.
The reason is that insurance companies are adopting new mortality tables that show people are living longer (three additional years for men, to 88.5 years; and two additional for women, to 90.3 years). This requires insurers to offer guaranteed lifetime payments for a longer period overall, and that means they have to offer lower lifetime income streams to remain profitable.
There may be some sunshine down the road to offset the clouds. New annuity buyers could catch a break later this year because the Federal Reserve recently started raising interest rates for the first time in nine years. Increases in short-term interest rates typically spark increases in long-term rates, with a lag. If this happens again, insurance companies would reap higher profits from their bond investments and likely increase payouts to try to jumpstart sluggish sales.
This scenario is still likely, despite growing economic and financial woes, albeit the timing of interest rate increases has been pushed back. In the end, all that is really clear today is that the interest rate outlook is highly uncertain, boding well for a new 2016 annuity buying strategy.
Agents and brokers should continue to advise prospective annuity buyers not to postpone their purchase, even though interest rates now appear stalled. However, they should adopt a new twist in approaching investors ...
Annuities could certainly be more generous, but they still pay much higher interest rates than bank CDs and are almost as safe. In addition, a delay in purchasing annuities forces most investors to turn, in the interim, to conventional investments, such as stocks and bonds. These currently offer poor prospects. Consequently, what prospective annuity buyers should consider today is building a ladder of fixed annuities with different maturities, which offer decent interest rates and which hedge, in part, against the risk of rising rates.
For this option, Multi-Year Guarantee Annuities (MYGAs) should be the investment of choice. These are unaffected by mortality table changes and generally pay 2 percent to 3.25 percent annually for three to 10 years, and taxes, unlike a CD, are deferred until withdrawal in a non-IRA account. This allows the annual yield to compound and grow more.
Predictably, there are multiple paths to carve with a MYGA ladder. But for illustration purposes, one good one would be the assembly of a ladder containing a three-year, five-year and seven-year MYGA. At current rates, these pay 2 percent, 2.65 percent to 2.8 percent, and 3 percent respectively (if clients want the option to withdraw 10 percent of principal without penalty).This provides some protection against the uncertain timing of interest rate increases. Should long rates rise after three years, for example, the buyer could collect the money from the three-year MYGA and transfer it into a lifetime income annuity paying a higher rate than available today. The two other, longer-term MYGAs increase the odds of an investor hitting an interest rate sweet spot.
In a nutshell, the buyer of a MYGA ladder fares better if rates rise but is not hurt if they do not.
Another option agents and brokers might want to introduce to investors is the purchase of an attractive alternative to annuities with, admittedly, a cumbersome name — an indexed universal life policy with an equity index feature. This would make as much sense as a MYGA ladder, perhaps more, if the prospective buyer has at least $100,000 to invest, is in good health and wants a shot at capital gains.
Some of these products offer as much as a guaranteed annual interest rate of 3 percent (minus fees of about 1.5 percent, netting the same return as a 2-year CD) and a high ceiling of up to 12 percent annually on the S&P 500 stock index. Policy holders receive whichever is higher. In addition, the owner can get out of the policy at any time without penalty, unlike annuities, and buy a higher-paying lifetime income annuity in the future, if he or she so chooses. (These policies are solely for non-qualified non-IRA and non-401(k)) money.)
More people would probably prefer the MYGA ladder option because it offers higher rates and an interest rate hedge — a significant attraction given that interest rates are highly likely to rise at some point and prod insurance companies to improve payouts to offset the new mortality table-induced cuts, simultaneously stimulating sales.
Insurers would like to take some positive action if they can afford it. Annuity payouts started dwindling well before the introduction of new mortality tables, mostly because of record-low interest rates. This has hurt sales. In the first nine months of 2015, total annuity sales totaled $170 billion, down 2 percent from the same period in 2014, according to the Insured Retirement Institute.
By contrast, annuity sales were growing as much as 10 percent annually a decade ago.
Some huge annuity vendors, such as Nationwide and Guggenheim, have already begun to improve terms on select annuities. When interest rates eventually start climbing, watch for them and many of their competitors to roll out still more attractive annuities. The mortality table issue won’t disappear, but it will become more palatable.