The Fed’s rate cuts are reshaping the annuity market. While some annuity types benefit, others face challenges. Discover how these changes could influence your retirement strategy and why annuities remain a valuable tool for income guarantees and long-term financial planning.
Fed Rate Cuts and Interest Rates
After much anticipation, the Fed began interest rate cuts in September, marking the first reduction since the beginning of the pandemic rate hike cycle. The primary goal of cutting interest rates is to reduce borrowing costs and encourage spending and investment, therefore boosting economic activity. Interest rate cuts typically are a positive for many areas of consumers’ finances, for example, lower costs for debt payment streams like mortgages and car payments. However, the implication of lower interest rates for annuities is more complex. Rising interest rates have driven a surge in annuity sales over the past two years and for good reason. With higher interest rates came higher income guarantees and higher fixed interest accumulation rates, making many annuity products very attractive.
What Rate Cuts Mean for Annuities
So, what does this and future rate cuts mean for annuities? The answer can vary by the type of annuity.
Variable Annuities (VAs)
The value invested in variable annuities rises and falls based on the market performance of the underlying funds. For bond funds, falling interest rates may improve underlying returns. Equity funds, on the other hand, are less likely to be impacted by Fed rate policies because they are tied to markets rather than interest rates. When rates drop, investors may shift towards these types of products in search of higher return potential.
Registered Index-Linked Annuities (RILAs)
The value invested in registered index-linked annuities is linked to the performance of external indices, subject to various parameters that may limit downside losses or upside gains. Like VAs, returns will vary based on the type of index that performance is linked to, with many indices being unimpacted by Fed rate decreases. However, insurance companies purchase options to support the guarantees of RILAs, and the cost of these options generally determines the upside potential offered. Because lower short-term interest rates can lead to lower option costs, this could mean higher upside potential offered on RILAs. Due to the neutral or favorable impact of lower interest rates on RILAs, investors may shift to these products in a lower interest rate environment.
Fixed-Index Annuities (FIAs)
Like RILAs, the value invested in fixed index annuities is linked to the performance of external indices, but with protection from all losses in exchange for less upside potential compared to RILAs. Also, like RILAs, FIAs will benefit from lower hedge costs if short-term interest rates decrease. However, if longer-term interest rates also decrease, the upside potential offered by FIAs will weaken. Consequently, investors are unlikely to gravitate towards these products if interest rates drop.
Fixed Annuities
Fixed annuities provide a guaranteed and specific return, regardless of changes in the interest rate environment or the stock market’s performance. As such, investors who own fixed annuities are unlikely to see any impact during their rate-guarantee period. However, the rates offered for new purchases of these products will likely be lower in a lower-rate environment. As guaranteed fixed rates decrease, less risk-averse investors may look toward VAs and RILAs linked to market performance in hopes of earning higher returns.
Income Annuities
Income annuities are not as impacted by interest rate cuts because Fed rate cuts impact the short-end of the yield curve more than the long-end. Because income annuities typically have a longer investment horizon, Fed decisions may not impact the rates offered on these long-term products as heavily. However, to the extent that longer interest rates do decrease, this will result in reducing the income payment guarantees offered for new purchases of income annuities but will not impact the guarantees offered on in-force non-variable income guarantees. In reaction to a lower interest rate environment, some investors may choose to delay purchasing an income annuity in hopes of future rate increases.
The impact interest rate cuts have on annuities varies significantly based on the type of annuity and whether you already own the annuity or are looking to buy one. However, it is important to remember that interest rate environments do not change the fundamental benefits of annuities: their unique ability to provide income for life guarantees, tax deferral and customization to an individual’s goals and risk tolerance. A lower rate environment certainly may cause investors to favor one type of annuity over another, but these annuity benefits are still valuable even if the Fed reduces rates. Individuals should take advantage of this moment in time and discuss their options with a financial professional to better lay out their retirement planning and best prepare for the future.
The views expressed here are those of the author and do not necessarily represent the views of TruStage.
TruStageTM Annuities are issued by CMFG Life Insurance Company (CMFG Life) and MEMBERS Life Insurance Company (MEMBERS Life) and distributed by its affiliate, CUNA Brokerage Services, Inc., member FINRA/SIPC, a registered broker/dealer, 2000 Heritage Way, Waverly, IA, 50677. Investment and insurance products are not federally insured, may involve investment risk, may lose value and are not obligations of or guaranteed by any depository or lending institution. All contracts and forms may vary by state and may not be available in all states or through all broker/dealers.
Editor Norah Layne contributed to this article.
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