Positioning indexed annuities in low interest rate environments

Three reasons why waiting before investing in FIAs may not be in the client’s best interest.

Everyone is feeling the pressure of low interest rates these days — consumers, producers, distributors and manufacturers alike. If you’re like me, you are checking treasury rates two to three times a day … sometimes more. This pressure has resulted in adjustments to both fixed and index-linked interest-crediting rates across the industry. Because of this low rate environment, producers and clients often question if now is the right time to invest in a fixed indexed annuity. Shouldn’t they just wait until rates get back to where they were?

Not necessarily. Waiting for interest rates to return to normal before investing in fixed indexed annuities may not be in the best interest of clients.

First, there is no guarantee that rates will rise anytime soon. Economic indicators seem to point to this low interest rate environment persisting over the next couple of years, and it may even last longer. In fact, the Fed has indicated rates will remain near zero at least until late 2014. Even if we do see treasury rates increase, it might not be a spike. It might be a slow, steady climb. And there is always the chance they may fall again. Ten-year treasury rates over the past few years are a prime example. After dropping to 2.38 in October of 2010, the 10-year climbed back up to 3.72 in February of 2011. In September of the same year though, it dropped again, this time down to 1.72. It climbed back up to 2.39 in October before dropping again to a historic low of 1.43 in July of 2012.1

The fact of the matter is no one can predict when interest rates will rise. If your clients are currently in equity investments, their principal is not protected and there is no guarantee of growth. If they are in deposit products, they are most likely dealing with low yields with limited or no opportunity to participate in market performance. The point is that while clients are waiting, they are missing out on the protection and interest-crediting potential that can be found in fixed indexed annuities. This leads to the second point.

The longer clients wait, the longer it may take to achieve their financial goals. It is likely that many clients who are invested in CDs, money market and/or savings accounts are generally not happy with the return they are currently getting. Most fixed indexed annuities provide minimum guaranteed growth that is probably as good as, or maybe better than, what they are currently experiencing. At the same time, fixed indexed annuities also provide interest-crediting potential based on the performance of one or more market indexes. This gives them the opportunity to receive interest credit that is higher than the minimum guarantees and, consequently, get closer to achieving their financial objectives, instead of falling behind.

One may argue, though, that there’s no guarantee the equity markets will experience positive performance over the next few years. That’s where the third point comes in.

By attaching a living benefit rider to a fixed indexed annuity, clients are guaranteed income growth even if equity markets and interest rates do not improve. Most fixed indexed annuities on the market today offer the option of adding a withdrawal benefit rider for an additional cost to provide a guaranteed stream of income for the rest of your life. This income stream can grow through deferral bonuses, annual step-ups or through increased payout percentages as the client ages. So even if the equity markets go down every year, clients are still able to increase the amount of income that will be available to them when they decide to turn it on.

Another important thing to keep in mind is that many fixed indexed annuities offer premium bonuses that provide an immediate increase to the account value, which can result in even greater interest-crediting and income-growth potential.

Consider the following hypothetical example: Jon Smith is 60 and plans on retiring in five years. Equity investments are not an option because he can’t run the risk of losing principal at this stage in his life. At the same time, he still wants to see his assets grow as he gets closer to retirement. He is currently looking at putting $100,000 in a five-year CD that provides an annual percentage yield of 1%, but he was hoping for a higher return. Jon is considering holding off until interest rates rise but is worried that waiting may mean he has to postpone his retirement.

Let’s assume Jon decides to put $100,000 in a fixed indexed annuity with a five-year surrender charge period and a minimum guaranteed interest rate of 1%. This means if Jon does not take any excess withdrawals during the five years, he is guaranteed to walk away with $105,101, the maximum amount he would have walked away with if he had elected to purchase the five-year CD. Jon also has the flexibility to allocate his principal among multiple interest crediting strategies that provide the opportunity to receive additional interest credit based on the performance of a market index. Based on the crediting method selected, this could provide annual interest-crediting potential of 10% or greater. He also decides to add a withdrawal benefit rider that provides a 5% compounding roll-up to the income base. If Jon defers taking income payments until after the five years, the amount his income payments will be based off of will be $127,628.

So, instead of waiting, Jon has the assurance of principal protection, a minimum interest guarantee, upside potential based on the performance of a market index and guaranteed income growth. When you combine this with the other important features found in fixed indexed annuities, such as tax deferral, annual free withdrawals, and flexibility to choose among different interest-crediting strategies, the case becomes even more compelling. It is important to remember fixed indexed annuities are long-term financial products that include surrender charges for taking excess withdrawals prior to the end of the surrender charge period.

While there may not seem to be an obvious choice in today’s low interest rate environment, fixed indexed annuities offer a solid option to help clients achieve their financial goals. As clients risk losing assets invested in equities waiting for markets to surge or miss upside potential sitting in CDs or other low-yielding bank products, fixed indexed annuities offer protection, guarantees and growth potential today.

By Brian Wilson From the October 1, 2012 issue of Life Insurance Selling. Brian Wilson is assistant vice president, senior product manager, annuity solutions, at Lincoln Financial Group

Footnote: 1.www.treasury.gov

 

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