The interest rate on your annuity contract is one factor that can affect your income payments later on. How your annuity earns interest depends on the type of annuity you purchase.
Plus, interest rates can also change over time, so it’s important to be mindful of the parameters on the annuity you purchase and how those might affect your earnings later on.
Learn more about how annuities work
How do federal interest rates impact annuity returns?
Generally speaking, rising interest rates at the federal level can be favorable for life insurers. “When interest rates are high, insurance companies can re-invest your premiums at higher returns, which means they can offer you more in your annuity payments, depending on the structure,” says Nadia Vanderhall, financial planner and founder of The Brands and Bands Strategy Group, a financial planning and education firm.
By contrast, “lower rates could lead to lower annuity payouts. In a low-interest-rate environment, insurers earn less on their investments, so the payments to you are lower,” Vanderhall says.
Ultimately, your interest rate is just one factor that affects your annuity earnings — and it’s secondary to your life expectancy and the payout schedule you’ve selected. It’s important to “be mindful of not only the interest rates, but also the fees that can impact the future growth of your annuity,” Vanderhall says.
How do interest rate changes affect fixed annuities?
The interest rates set by your insurer can also impact your earnings. Many fixed annuities offer a fixed interest rate for a guaranteed rate period — often a year, but sometimes longer depending on the contract.
At the end of the rate period, the insurer can set a new fixed rate. Typically, there’s a guaranteed minimum return you know you’ll earn, so the interest rate could be equal to that guaranteed minimum, or it could be higher.
“As interest rates go up in these guaranteed products, our goal result per year is going to be a higher amount. Or, if it’s goal specific, we’ll get there at an earlier age,” explains Jose V. Sanchez, a certified financial planner in New Mexico who specializes in retirement wealth. In other words, if you have a target amount of money you’re looking to save, higher interest rates will help you get there faster.
Can you withdraw money from your annuity?
Impact on potential returns
Fixed annuities offer you the opportunity to earn modest returns with low investment risk. If your primary focus is market growth, you may want to consider a different type of annuity. On the other hand, if you’re more risk averse and you want to protect your principal, a fixed annuity could solve that need in your financial portfolio.
How do interest rate changes affect variable annuities?
Variable annuities offer you more control over how your principal is invested — your interest rates will depend on your selected investments. Variable annuities offer you the opportunity for more growth, but they also expose you to a higher degree of risk than, say, fixed annuities. For this reason, they’re also regulated by FINRA and the SEC. [1]
Impact on potential returns
Most variable annuities are deferred — meaning your income payments don’t start right away, and they’re used for long-term investment goals.
When the market is performing well, you’ll likely earn a higher interest rate. In turn, the payments you receive will likely increase, too. When the market is down, you’ll earn less interest — variable annuities don’t often come with principal guarantees, so you could lose money.
However, some variable annuities offer you the choice of a subaccount with a fixed, low interest rate, so there are ways to allocate part of your principal toward safer investments if you choose.
Ultimately, variable annuities expose your funds to market volatility, which can make it hard to plan for how much interest you’ll earn, or exactly how much your income payments will be.
Learn more about the differences between fixed and variable annuities
How do interest rate changes affect indexed annuities?
Indexed annuities allow your funds to grow based on a market index, but with safeguards in place. Indexed annuities limit your losses up to a certain extent (for example, fixed index or equity index annuities typically have a floor of 0%). [2]
In return for this downside protection, indexed annuities also cap your gains. For instance, if your annuity has a cap of 8% and the market overperformed by 10%, only 8% would be credited to your funds.
Can annuities be used as collateral for a loan?
Impact on potential returns
Indexed annuities can offer you growth potential with some downside protection in the form of buffers or floors. However, the exact parameters will depend on the specific contract you purchase. Indexed annuities can vary widely in terms of investment risk, since it depends on the caps and floors of the specific contact and the insurer’s offerings.
Like variable annuities, most indexed annuities are deferred, which allows you time for your investments to grow.
Learn more about the different types of annuities
How can annuity interest rates affect your overall financial plan?
Interest rate changes can affect your financial goals and how quickly you reach them. For instance, “if I’m solving for a million-dollar portfolio at age 65, higher interest rates means it’s more affordable for me to reach that goal,” Sanchez says.
“That means it takes less of my dollars to reach that mile marker. And if I choose to put more, that means the mile marker will come sooner — at say age 62 or 63. Or, at 65, I’ll have $1.5 million.”
However, it’s important to keep in mind the difference between a guaranteed interest rate, and potential gains. “One of the rules of thumb that I follow whenever we consider annuities, is that we consider it for what it will do — the guarantees of it.”
So for instance, with a fixed index annuity, you know it won’t lose money, but we also know that, “the idea of market-like returns isn’t a fair statement for all [annuities],” Sanchez says. In other words, some annuities — like variable annuities — have higher growth potential than others — like fixed annuities.
It’s important to consider the stipulations of the specific contract you’re considering, and how the insurer is investing your money. If you’re not sure where to start or how interest rate changes will impact your contract, you can reach out to an annuities professional or financial planner for help.
