Plunging long-term interest rates over the past three months have the stock and bond markets cheering at the end of 2023. But not everyone is a winner.
Payout rates on income annuities — insurance products that convert a pile of savings into a lifetime pension — have started coming down, as well.
If interest rates follow predictions and keep falling in 2024, you can expect annuity payout yields to plunge further, too.
And that’s bad news for those nearing retirement, especially if they need to squeeze the maximum amount of retirement income out of limited savings.
Lifetime-income annuities, typically known as single-premium immediate annuities, are insurance products that convert a pile of savings into a guaranteed income for life — in other words, into something resembling a traditional pension.
Given how often people complain about the death of the traditional pension, you’d think these products would be more popular. Instead, they accounted for a derisory $10 billion in sales in the first nine months of 2023, accounting for roughly 3% of the sales of all “annuity” products. The other 97% mostly consisted of high-fee investment products.
Economists think this is nuts, by the way. For nearly 40 years they’ve been debating why more of us don’t buy lifetime annuities when we retire.
Payout rates on annuities follow long-term interest rates. That’s because the insurance companies that sell annuities invest the premiums in Treasury bonds
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and investment-grade corporate bonds.
I wrote about annuities back in November, when long-term interest rates had only just started sliding. In mid-November, a 65-year-old man could still buy a single-premium immediate annuity with a 7.7% payout: In other words, if he paid $1 million he could get a guaranteed income of $77,000 a year for life. With rates for women lower because they tend to live longer, a 65-year-old woman could get a 7.3% payout, enough for $73,000 a year.
Where are rates today? In theory, they are — astonishingly — the same or even higher. Immediateannuities.com, an industry website, lists annuities of 8% and 7.7% for a 65-year-old man and woman, respectively. But these relate to one or two products in a thin market. Drill down a little and you’ll see that most yields are lower. If you want an insurer with the highest possible credit rating, you’re looking at rates of 7.4% and 7.1%.
Given the wild moves in long-term interest rates in the bond markets over the past six weeks, it’s surprising the rates haven’t fallen further. Since mid-November, 10-year Treasury yields
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have plunged from 4.5% to 3.9%.
It’s a similar story if you look at annuities with a cost-of-living adjustment. A 65-year-old man who buys a single-premium immediate annuity with a 3% annual bump in income could theoretically start with a 6% payout, or $60,000 as the first year’s income, on a $1 million premium. But from an insurer with the highest possible credit rating, that 65-year-old man is looking at 5.4% or 5.5% to start with, while a 65-year-old woman is looking at 5.1%. Rates have started to come down since mid-November, even if more slowly than you’d expect.
Why haven’t they fallen further yet? It’s partly because of the way insurance companies operate and how they create annuities, explains Rajiv Rebello, principal and chief actuary at Colva Actuarial Services in San Diego, Calif. Payout rates on new annuities may reflect the yields on bonds that the companies bought weeks ago. “They do buy Treasurys and corporate bonds to back the annuities,” he says. “But there is a delay between the drop in yields in the market and when the insurance company drops the payout rates.”
So the annuities that insurance companies are selling right now may reflect bonds they were buying before interest rates went into free fall earlier this month.
By that token, we can expect these payouts to plunge in the weeks and months ahead — unless interest rates start rising again. And don’t rule that out: Wall Street is so completely convinced that rates will keep heading down that the bond market is vulnerable to the slightest upset.
Whether or not we should buy annuities when we retire depends on many factors, financial advisers note. It’s worth taking advice from a fee-only adviser before taking the plunge. Standard advice usually suggests purchasing an annuity with some of your savings.
The real power of single-premium immediate annuities comes from the life-insurance component. Those who buy them and die young subsidize those who buy them and die old. The result is that each person gets an income for life — which is how pensions used to work.
A payout of 5% a year plus a 3% annual rise may not seem like much. But it’s a lot better than it was when bond yields were on the floor. Perhaps more important, it’s also well ahead of the so-called 4% rule — the common strategy of investing in a balanced portfolio of stocks and bonds, withdrawing 4% in your first year, raising the withdrawal each year in line with inflation and hoping for the best.
Now read: I’m 71 and can’t decide if I should pay off my mortgage or get a joint annuity that’s cheaper — what should I do?
And: Annuities, Social Security, inheritance: How much money do I need to retire?
