July 3, 2013

Should You Buy an Annuity Now or Wait?

As I right this interest rates are still generally very low.   Mortgage rates have gone up about 1% in the past month or two.   However Treasuries, munis and corporate bonds are still pretty low.   It is almost inevitable that sometime in the next couple years that interest rates will go up.   Annuity rates are based on interest rates at least in part.  The insurance companies that sell annuities base the payout rates on how much money they expect to get from their investments which is tied to interest rates.    When interest rates go up you'll see annuity payout rates go up as well.    Given that we're at very low interest environment right now it would follow that right now is not a great time to buy an annuity. 

I went looking for historical data on annuity payout rates.   I couldn't find much.   The Immediate Annuities site has data going back 10 years to 2003.    I think thats a good enough time period to see a good trend.   If you look at that site and find Chart 7 you can see the trend for a fixed immediate guaranteed life annuity for someone aged 65.   From 2003 to 2009 the monthly payment was around $600 give or take.   As of 2013 their data shows payouts around $500 range.   You can see in that chart how the corporate bond yields and the annuity payout rates move in the same direction.    I think its a safe conclusion that if corporate bond rates go up a couple % points then we'll see annuity payout rates go back to the rates we saw 5-10 years ago.  Just a few years ago annuities were paying out about 20% more than they are now.   It would follow that if you wait a few years and interest rates recover that annuity rates will also rebound.

Lets look at an example of how this might work.   Say you're 65 year old male and you've got $100,000 that you want to use to buy a fixed life annuity.

Option 1: Buy today. 
If you buy right now you'll get $545 a month for life.

Option 2:  Wait.
Lets say you decide to instead wait two  years before you by and hope that interest rates go up.  You could keep your money in safe bank CDs.   You could spend $545 a month in the meantime.  Thats $6,540 a year or $13,080 total.   After two years you'd be left with only $86,920 left.  If you bought an annuity with $86,920 at age 67 then todays rates would give you $492 a month.  However if interest rates go up 2% in the next couple years and annuities end up paying 20% more then you'd get $590.


If you want to take a little risk then waiting till rates recover may very well be worth it.   Of course it might backfire and maybe two or three years from now we could still be seeing relatively low interest rates.   However that doesn't seem very likely to me.

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2 comments:

  1. You can also diversify or do something like dollar cost averaging. Spend $50k on an annuity now and $50k on an annuity in two years.

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  2. My second-hand experience with annuities is that basically people who have been collecting payouts for more than 10 years have remarkably high payout rates, sometimes twice what today's rates are.

    I have been looking into annuities for some time, both for myself and for a family member with special needs. So far, the rates are not anything that I cannot duplicate myself with a combination of laddered FDIC insured CDs, and a schedule to drawdown the principal. This may change in the coming decades (I'm 53, my family member is 47); the risk of an early demise declines and payout increases. If nothing else changes, my mid-70s is when annuities might make sense for me. But a lot can change between now and then, and locking in a low-rate payout will also lock in my choices. Continued success to you, Jim R, I will continue to evaluate this subject in coming years and will look forward to your evaluation findings.

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