How do interest rates affect annuities? A guide to choosing the best annuity for you

Interest rates often come up in conversations about annuities because they directly affect the distributions these products can offer. You might hear, for example, that buying a fixed annuity can be more attractive when interest rates rise or that locking in a contract before interest rates are expected to decline can be beneficial over time.

While it's natural to consider the factors affecting annuity interest rates, timing the market to chase the "perfect" rate isn't advisable. Instead, focus on how an annuity fits your overall financial goals and personal circumstances. Remember that the main value of an annuity is the guaranteed income stream and predictable income you'll receive for the time period you've chosen.

Annuities are financial products offered by insurance companies that can provide a steady income stream, typically during retirement. They can gain earnings in different ways that depend on the type of annuity you purchase. For example, a common type of annuity is a fixed annuity, which is an insurance contract that provides guaranteed interest, offering stable and predictable income.

Interest rates play a significant role in determining the benefits of annuities. When interest rates rise, insurance companies can offer higher interest rates on annuities, making them more appealing to clients seeking stable income.

It's important to note that insurance companies base annuity rates on various factors, including the company's investment portfolios, expenses and risks. In addition, the insurance company considers the current rate environment as well as predictions regarding future rate changes.

The average interest rate of an annuity varies based on factors such as the type of annuity, the current economic conditions and the financial strength of the issuing insurance company.

Several factors influence annuity performance and suitability:

• Type of annuity. Fixed annuities offer guaranteed interest rates while fixed-indexed annuities have interest credited based on a market index, such as the S&P 500, subject to a cap.
• Fees and charges. Annuities may have fees such as administrative charges and surrender charges for early withdrawal, which can impact your overall return.
• Tax considerations. Fixed annuities are taxed as ordinary income when you withdraw the earnings, but your original principal (if funded with after-tax dollars) is returned tax-free. Also, if you are under age 59½, earnings also may be subject to a 10% federal tax penalty.
• Financial strength of the insurer. The guarantees provided by an annuity are only as strong as the issuing insurance company's ability to meet its obligations. Assess the insurer's ratings before purchasing an annuity.

Understanding these elements can help you make informed decisions about incorporating annuities into your financial planning, ensuring they align with your long-term goals and risk tolerance.

The 4 types of annuities you should know

Learn the pros and cons of the different types of annuities and how they can help ensure you won't outlive your money in retirement.

Explore types of annuities

Once you purchase an annuity, the minimum interest is fixed for the time period specified in the contract. When interest rates decline, the value of existing fixed-rate annuities may become more attractive because their interest rates are locked in at previously higher rates for the specified time period. This makes an environment of falling interest rates potentially favorable for existing annuities compared to what is being offered on new annuity purchases.

However, for people looking to buy an annuity, a reduction in interest rates still may provide the guarantees they are looking for to provide future retirement income.

Interest rates play a role in determining the value and appeal of annuities and their long-term benefits. Whether you're considering buying an annuity in a high or low interest rate environment, each scenario has advantages and drawbacks that can impact your financial strategy.

Understanding the pros and cons of annuities can help you make a more informed decision about when and how to incorporate an annuity into your portfolio.

• Higher interest rates translate to better returns for fixed annuities, providing greater income for your retirement.
• Locking in an annuity during a high-rate environment ensures your return remains competitive for the specified guarantee period, even if rates drop later.
• Immediate annuities purchased in high-rate periods often provide better lifetime income streams, especially for retirees.

• Even after you purchase an annuity, there is a possibility that interest rates can go higher. It is hard to predict interest rate movements in today's complex financial and political environment.

• While you may think it's a low interest rate environment, interest rates may continue to drop. Locking in a guaranteed interest rate still can provide the benefits you are looking for in your overall financial plan.
• If rates increase after your purchase, you still will benefit from having a guaranteed interest rate.

• Once you buy an annuity, you may have a surrender charge period that can affect how long you hold that annuity. If rates go up, you may choose to keep your original annuity instead of pursuing a higher rate product.
• Buyers may feel pressure to wait for interest rates to improve, potentially delaying their financial security plan.

• Consider the current rate environment. It's important to consider the economic environment and potential direction of interest rates when shopping for fixed rate annuities. Rising rates could lead to better future offerings while locking in a rate before they start declining may result in favorable long-term results. It is difficult to make predictions because of the many different factors that impact interest rates.
• Evaluate multi-year rate guarantees. Look for fixed annuities with multi-year guaranteed rates (such as MYGAs) as these ensure a stable return for a specified term.
• Consider the insurer's financial strength. Check an insurance company's ratings from agencies like A.M. Best, S&P Global Ratings or Moody's.
• Compare fees. Be mindful of administrative, surrender and rider fees, which can decrease your net return.

Annuity rates are impacted by prevailing interest rates and other insurance risk factors. That means they fluctuate with broader economic conditions. Determining if an annuity is a good choice for you depends on your financial goals, timeline and risk tolerance.

To choose the best annuity for your needs, start by identifying your goals.

For example, if you're looking for guaranteed interest in retirement, a fixed annuity can be a good fit. While prevailing rates are an important consideration, the predictability of income should be your primary focus. If you are looking for higher growth potential, other types of annuities, such as variable or indexed, may align with your priorities. Evaluate guarantees, fees and any added benefits, such as living benefits or death benefits, to find what's right for you.

While fixed annuity rates in late 2024 and early 2025 are currently below historical highs seen in the 1980s and 1990s, they are higher than in recent years, making them attractive for conservative investors seeking predictable income. Looking ahead, the direction of annuity rates depends on multiple factors. If the Fed continues to raise interest rates to combat inflation, annuity rates may rise further, enhancing their appeal. But if rates stabilize or decline, future annuity offerings may provide lower interest rate guarantees.

Taking time to evaluate rates in the context of your financial goals can help you make a confident decision about purchasing an annuity. However, remember that it's impossible to predict the exact trajectory of interest rates, and the key is to focus on your financial needs and long-term plans rather than trying to chase the highest interest rate. For example, when considering a fixed annuity, remember that its primary value is a guaranteed income stream and the predictable income you'll receive for the period you've chosen.

To better understand how annuities may fit into your retirement plan and how interest rates can affect them, consult with a local Thrivent financial advisor.