The Federal Reserve increased rates by 25 basis points this week, a remarkable turnaround from hoped-for cuts. Stubborn inflation has, instead, put the central bank in a position in which hikes were the right course — with further potential hikes in the offing. That has major implications for portfolios of all kinds, but one underexamined impacted area may be annuities.
Key Takeaways:
- Rising rates can improve annuities payouts, as rates help set the income in annuities policies.
- That could make now a good time to prepare to add an annuities policy, if rates do rise again this year.
- Fixed and variable annuities policies differ in important ways in how they operate and in rate impacts.
With their promise of steady, reliable income over a long period, annuities are a popular option for those at or nearing retirement. Offered by insurers, they come in fixed or variable structures, each with their own benefits. Rising rates impact annuities in some particular ways — opening up opportunities and potential risks.
How do rates impact annuities? When you take on an annuity policy, you engage in a long-term contract with an insurance company. After the investor provides a lump sum, they agree to receive income at a certain rate over a long period of time, often guaranteed income for life.
Rates have a big role to play in setting that income amount. Along with one’s age, gender, amount of money invested, and other factors, rates themselves help determine income amounts.
As such, now could be a good time to get into annuities — or even later, if rates rise further. Overall, it makes annuities a more appealing option in the race for retiree dollars, competing with options ETFs and bonds for steady income in retiree portfolios.
What kind of annuities are available, then, for investors to consider? Fixed and variable annuities stand out as the most popular with some important differences. Fixed annuities offer a guaranteed interest rate, protecting the invested principal in choppy markets. Variable annuities, by contrast, offer more market upside at greater risk to that principal.
How, specifically, do those annuities work? Both are deferred annuities, allowing investors to add to that nest egg and receive the income later. Furthermore, that also defers taxes on both types of annuities.
Fixed annuities, designed with the more conservative investor in mind, have some notable strengths to consider. They earn interest during the “guarantee period.” Investors agree on a guaranteed rate for a period of two to 10 years. With those strengths come limits, however, on when and how much can be withdrawn.
Variable annuities offer some of that market exposure, by contrast, but of course with added risk. Both the income and growth available via those annuities depends on the markets. Intriguingly, variable annuities empower investors to decide how the money in the contract is invested. That adds both risk and upside opportunity.
Rising rates have implications for both categories. Not only do they impact the payouts available via annuities, but for the latter, especially, rate shifts matter for equities, too. Rising rates both correlate with and impact shifting outcomes in stocks. As ever, investors can learn more about annuities as an opportunity set from big annuities shops like MassMutual to see if the space is right for them now.
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