Annuities do not exist in a parallel universe. The global economic downturn of 2008 has affected most financial instruments; precipitating a drop in interest rates. Predictably, the annuities borne by various insurers and financial institutions have been affected to a greater or lesser extent.
Even though the rates on annuities have declined somewhat, the benefits of purchasing them in good times still apply in financially tumultuous times. There are three basic reasons for purchasing annuities when interest rates are dropping.
1) Higher than average market rates
Annuities generally offer better rates than you’d get from income options elsewhere. Generally, to obtain higher returns than an annuity, you’d have to invest in growth options (mutual funds and stocks for instance). Even though annuities are being affected by the fall in interest rates, they still offer better average returns than Money Market Funds and Certificates of Deposit (CDs).
2) Capital guaranteed
With most regulated annuities, the premiums invested by an annuitant are fully guaranteed. In these times, people fear losing money because of the liquidity crunch and lower economic growth. Devastating investment failures characterised 2008. Many annuities provide a guarantee that is backed by the provider’s credit rating, reserves and policy contract.
3) Base guaranteed-interest rates
Besides guaranteeing capital, most annuities have a safety net for the interest rates. The base interest rate is a threshold that the annuity’s accumulation rate may not go below- even in terrible times. Where interest rates are declining to 3% elsewhere, for example, an annuity may stipulate that the interest rate may not fall below 5% or 3.5% in a worst-case scenario.
4) Tax treatment
Saving for retirement and other needs is even better when you get a tax break for it. Unfortunately, tax exemptions are not provided on the basis of financial crises. Reducing taxes is also a great way to boost the real return on annuities. Favourable tax treatment or tax exemptions are a prime benefit of the annuity in any season.
5) Fund management
Many annuities operate in a regulated environment. It is typically safer to invest in funds that have oversight or are heavily regulated. Annuity providers must ensure that they honour their liabilities to annuitants and have to adhere to the demands of a regulatory body in order to remain a going concern.
The reasons for buying annuities when interest rates are dropping do not constitute an unqualified endorsement of annuities. There would be drawbacks to annuities, such as loss of ownership of funds at maturity, which are not mitigated in economic downturns. Some annuities- like variable annuities- are of limited value, especially when ‘pie-in-the-sky’ returns are projected.
It is important to be selective in purchasing an annuity whether interest rates are rising, stagnating or falling. Annuities that are of dubious quality would remain that way in all seasons. Also, an annuity is a contract that you’ll purchase only if it satisfies a need. You wouldn’t use twice the amount of table salt in your food because you got a good deal on it! However, if you need an annuity, the benefits are magnified now that interest rates are falling.