Impact of the Fed's Interest Rate Increase on Annuity Rates
Jan 18, 2023
Blueprint Income Team
The Federal Reserve recently raised short term interest rates by 0.25%, but how does this impact annuity payouts? Learn what factors, in addition to changes in interest rates, can affect your annuity payout.
- Annuity payouts are determined by long-term bond yields (think the 10 year and 30 year)
- The Fed raising rates was already "priced in" to annuity payouts
On March 21, the Federal Reserve, our country’s central bank, raised short-term interest rates by 0.25%. It was the first time this year and the 5th time since 2015. At least two more interest rate increases are expected before the end of the year.
So, does that means higher annuity payouts are around the corner? Not exactly. Fed rate increase announcements don’t usually equate to higher annuity payouts. And there are a couple reasons for that.
Table of Contents
1. There’s a Difference Between Short-Term and Long-Term Interest Rates
Annuity payouts are determined by long-term bond yields (think the 10 year and 30 year), and this is something that the Federal Reserve has less control over via their monetary policy. Short-term Treasuries (those maturing in 3 months, 12 months or even 2 years) are most responsive to the Fed’s actual or expected actions. What’s happened over the last year is that short-term Treasury yields have increased dramatically (in response to the Fed’s actions), but the 30 Year Treasury yield has barely budged.
2. The Fact That the Fed Committed to Raising Short-Term Interest Rates Wasn’t a Surprise — It Was Already “Priced in”
What this means is that the market had expected the rate increase in March and also had already come to expect two more rate increases this year. The Fed seeks to telegraph its moves very carefully — if you’re a central banker, it’s good to not be in the business of surprises.
From a monetary policy perspective, what might move annuity payout rates is more rate increases than previously expected, especially if those rate increases are assumed to be sustainable over the long-run. Although monetary policy (i.e. the Fed) is important in determining what future annuity payouts will be, it’s just one factor.
What Else Affects the Long-Term Bond Yield That Impacts Annuity Payouts?
Other key variables are fiscal policy (e.g. the government’s spending levels), macroeconomic data (e.g. unemployment and inflation), and market conditions (e.g. the relative attractiveness of riskier stocks to lower risk bonds).
We don’t have a crystal ball to tell you what will happen with rates from here and are skeptical of anyone who says they have that crystal ball. What we do believe is that diversifying across interest rate environments is the right approach.
So, what bearing should all of this have on your decision to purchase an annuity? The prudent approach is usually to think about an annuity purchase the same way you invest in the market — do it in small amounts over time and avoid trying to “time” anything. By purchasing income annuities in small increments over time, you can benefit from higher rates starting at a younger age and still have the ability to capture increasing annuity rates in the future.
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Blueprint Income Team
We are a team of finance, insurance, and actuarial professionals working to make it easier for everyone to achieve a steady and comfortable retirement. We write about annuities (the good and the bad) and provide strategies to help Americans prepare for retirement.