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January 4, 2015
What could be better than income you can depend on throughout your retirement? That’s why annuities were born, and why so many people have chosen to invest their money in these low-risk insurance products.
But a funny thing happened on the way to the bank a few years ago. A zero interest rate policy (ZIRP) turned annuities into a less-than-appealing way to invest for retirement. Fortunately, that’s all about to end, and annuities are beginning to look like an attractive addition to retirement portfolios.
It might be time to give annuities a second look.
What is a Zero Interest Rate Policy?
When interest rates are up, financing purchases such as a new house or vehicle costs you more money. The higher the interest rate, the more you will spend over the term of the financing agreement. But on the flip side, high interest rates also result in better returns on savings.
As the economy headed into a tailspin, a zero interest rate policy helped stimulate spending by making it more affordable to finance purchases. If you bought a house in the 1980s, you might have paid as much as 19 percent interest, at least until you refinanced later, which is a rate that’s unfathomable today. Interest rates fell in the 1990s, but the relatively super-low interest rates on mortgages and other purchases today are the result of the Federal Reserve implementing ZIRP.
How Did ZIRP Affect Annuities?
Where ZIRP helped with financing large purchases, the effect on annuities was different. It made them less affordable, and therefore less attractive, than before. When interest rates are too low, it costs investors more money to purchase an annuity insurance product that has a guaranteed percentage rate of return. If you wanted $1,000 per month in retirement income, the low Federal Reserve rate meant you’d need a more expensive policy to get it. However, low rates didn’t hinder some investors, because annuities are generally much more stable than a volatile stock market.
According to Wall Street Sector Selector, investors should get more for their money once the Federal Reserve lifts the zero interest rate policy in 2015. Annuities have limitations, though. Life Health Pro explains that investors can only invest up to 25 percent of their non-Roth IRA funds into certain long-term annuity contracts.
ZIRP has helped buyers commit to large purchases, which boosted the economy.
The Bottom Line
Lifting the zero interest rate policy probably won’t cause a widespread rush to purchase annuities. The same drawbacks that have always existed still do. High yield rates may, or may not, last throughout your retirement with some types of annuities. Fees are also something to think about. Annuities aren’t cheap, and you’ll be hit with early withdrawal penalties if you need your money sooner.
Deferred taxes can be a great thing now. But like every other tax-deferred option, it’s only temporary. You will pay taxes on your annuity income once it starts paying out.
The lifting of ZIRP could change a lot about the way you spend and invest. Whether it’s a good thing or bad remains to be seen. Long-term financing will cost more when the rates go up, and that can create some ripples in the economy.
An annuity isn’t likely anyone’s sole retirement plan. More often it’s a way to diversify with a little stability and a lot less volatility. And it’s about to become a bit more affordable.
NewRetirement has the tools to help you chart the best course for your future. With our online automated retirement planning, you’ll get personalized results that help you find a strategy that works.
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