Low interest rates can complicate fixed-rate annuity
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With so much uncertainty in the markets in recent years, it's not hard to see the appeal of a fixed annuity as a secure way to save and generate guaranteed income during retirement.
But with interest rates currently at a historic low point, right now may not be the greatest time to buy one.
"Low interest rates and the threat of inflation make fixed annuities unattractive for people saving for retirement," said Anna Pfaehler, chief compliance officer and client service manager at Palisades Hudson Financial Group in Scarsdale, N.Y. "Savers earn less interest while their future purchasing power erodes."
While there can still be situations where an annuity is a good option to consider -- even with low interest rates -- investors should understand the nuances of the products available.
Fixed annuities are offered by insurance companies to investors who want certainty that they will not outlive their retirement savings or not have to worry about their money being wiped out in a stock market crash. The insurance company guarantees the investor a stream of income at a specified interest rate based on the amount they paid for the annuity.
Some annuities will pay investors for the rest of their life. Others will pay for a specified period of time.
For instance, investing $100,000 in a single-life immediate annuity paying 2 percent with a 15-year payout period will yield $644 a month for the annuity owner. The vast bulk of the income is his own principal being returned by the insurance company. At the end of 15 years, the annuity will be worth zero and he will have netted only $15,920 in total interest.
With a deferred annuity, on the other hand, an investor's initial deposits grow tax-deferred during the accumulation phase before the payout begins. Investors can save money in a deferred annuity and convert it to an immediate annuity when they are ready to collect steady checks.
"When you lock in a low guaranteed interest rate on an annuity, you're ensuring you'll lose purchasing power if there's any inflation," Ms. Pfaehler said. "Your monthly payout 10 or 15 years down the road will not buy as much as it would have in the beginning."
Jane Bryant Quinn, a personal finance columnist for AARP Bulletin, said fixed annuities are generally a bad deal for new retirees because of low interest rates and the risk of inflation. But some retirees can still benefit from them.
"It's potentially a different story for older people -- say early 80s -- worried about outliving their money," said Ms. Quinn, author of "Making the Most of Your Money."
"Social Security gives them inflation raises. The fixed annuity guarantees income for life. Its purchasing power might decline, but better 'some' purchasing power than running out of money."
While annuity investments are still popular, sales are not growing at the same pace they have in previous years, based on data reported by Morningstar Inc. and Beacon Research.
Industrywide sales for the third quarter of 2012 reached nearly $52.9 billion for all annuity investment products, down 4.3 percent from $55.3 billion the previous quarter last year.
Year over year, fixed annuity sales decreased nearly 13 percent to $16.6 billion in the third quarter of 2012 from $19 billion in the third quarter of 2011.
The year-over-year sales figures only apply to fixed annuity sales, and do not include variable annuities, index annuities and CD annuities, which make up a sizeable portion of the annuities market.
Cathy Weatherford, president and CEO of the Washington, D.C.-based Insured Retirement Institute, said the renewed attention to income annuities stems in part from a report issued last year by the U.S. Government Accountability Office, which concluded that annuity ownership offers predictable income that can reduce the uncertainty that comes along with managing investments and drawing down assets.
"I believe this quest for certainty is helping to keep industrywide sales relatively steady, despite the current low interest rate environment," Ms. Weatherford said.
Retirement savers who do want to buy a fixed annuity, according to Ms. Pfaehler, should wait until rates rise.
Jumping into an annuity contract now will not be easy to undo later. Fees for leaving early can be severe in the early years of the contract, making it financially painful to switch to a new one.
Instead of investing in an annuity, she suggests taking a balanced approach, dividing money between short-term bond funds and a diversified portfolio of U.S. and foreign stock funds.
"In addition to the opportunity for future appreciation, many stocks today offer generous income, paying higher dividend rates than annuities, with the ability to raise dividends periodically," Ms. Pfaehler said.
"It is certain that inflation will rise again someday, so avoid investments like fixed annuities that lock in today's low rate."
First Published February 12, 2013 12:05 am