23 Sep How do I figure out annuity interest rates and is now a good time to buy?

Q. How do I determine the annual interest rate — not the payout rate — I am earning on a single premium immediate annuity (SPIA)? It seems there is no simple way to determine how to do it. Also, is this a good time to purchase a SPIA since it is partly determined by long-term bond rates and not affected by the Fed’s short term interest rate hikes?
— Unsure

A. There’s a lot to unpack here.

You need to make a few calls.

To determine the annual interest rate for a single premium immediate annuity (SPIA), you should start by speaking to the insurance agent who sold you the product, said Marc Alan Lescarret, a certified financial planner with Marc Alan Wealth Management in Rockaway.

Even if you think you have the answer, he said, double-check with a licensed insurance agent because there is room for error. Each product is subject to the issuer’s credit risk and may have different terms and conditions, he said.

“An annuity means a series of payments in exchange for a payment and is relevant to insurance products and bonds,” he said.

In your case, you should have the following known values: The amount you invest, the monthly payment, the ending value, and the length of time, assuming you choose a fixed number of years.

Lescarret said if you want to do internal calculations on the interest rate of an annuity, you will need a financial calculator.

“The math can get tricky, and there is lots of room for error, so again, speak with an insurance professional or a professional who handles your type of product before you make a final decision,” he said.

Lescarret offered this example.

Let’s say you invested $100,000. On the financial calculator, you would list this as a negative present value because it’s money out now: PV= -$100,000

Let’s assume you purchased a 10-year product that pays at the end of each month: N= Number of years; 10 x 12 months in a year = 120 payment periods

Assume the company promises $947.72 at the end of each month: Pmt= $947.72

At the end of the 10-year term, after all of the monthly payouts are complete, it will have an ending future value of $0. FV=0

“Now it’s time to solve the unknown interest rate,” he said. “When I hit the calculate button for this example, I get 0.2175%. However, we are looking for the annual interest rate, so we need to multiply the monthly rate by 12 to get the annual rate: I= 0.2175 x12= 2.61”

In the above example, the product pays a fixed interest rate of 2.61%, Lescarret said.

Note that this calculation is just an example and you still need to get the details about your policy.

As for whether now is a good time to buy an annuity, Lescarret said he prefers a well-balanced and diversified investment portfolio of stocks, bonds and alternatives.

“Everything has some sort of risk. It just presents itself in different forms,” he said. “There is no risk-free solution.”

He said he believes that interest rates will continue to rise for both short- and long-term parts of the curve.

In today’s market environment, there is no sure thing, and no one has a crystal ball, Lescarret said.

“An old-school oversimplified school of thought is that the interest rate risk is amplified for every year of maturity added to a bond-like investment,” he said. “The price of a typical bond will move in the opposite direction of the rate move.”

So, he said, you can make a ballpark assumption that a 10-year bond could lose 10% if rates move up 1% in a surprise fashion, and a 20-year bond could lose 20% of its value for the same 1% move.

“Some bank, insurance, and private investments are illiquid, so you don’t see a change in your principal value, but you get hurt when you are locked into a low-interest rate,” he said. “The above example locks in your money at 2.61% for 10 years, but what happens if inflation stays above 3.5% and new high-quality bonds are paying 4 to 5-plus percent a year for the next 10 years?”

In the alternative scenario, if we get a significant recession, the long-term rates will plummet, he said. If this event occurs, many high-quality long-term bonds will appreciate, he said.

“Many insurance products may not participate in this appreciation, and then you might be faced with a more significant problem, the credit or default risk of the insurance provider,” he said, noting there is no guarantee that you will get what you expect. “If you lock in a shorter period, I would be less concerned, but a lot can happen if you lock in lifetime payments. I heard the phrase `that hasn’t happened before’ too many times.”

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This story was originally published on Sept. 23, 2022.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.