An environment of rising interest rates and volatile investment markets has prompted more advisors and clients to consider incorporating annuities into their retirement income stream. But will demand hold if interest rates plateau or start falling?
Daniel Walsh, senior vice president and head of individual insurance and annuities at BMO Insurance in Montreal, points out that while short-term interest rate fluctuations affect mortgages, lines of credit and guaranteed investment certificates (GICs), it’s long-term interest rates that matter for annuities. And as long-term rates have moved upward, BMO Insurance has seen interest in annuities rise to levels not seen since before the pandemic.
“Unless you have a traditional [defined-benefit] pension plan or a diversified portfolio generating income well in excess of your expected income needs, having a source of guaranteed income is very important,” he says.
“An annuity provides a series of periodic income payments for life, [so] you cannot outlive your income payments.”
If interest rates begin to drop, Mr. Walsh expects some people will turn back to alternatives that benefit from declining interest rates while also providing monthly or quarterly interest income – including fixed-income mutual funds and exchange-traded funds. Blue-chip dividend-paying stocks are another option. Of course, neither guarantees performance or income.
However, even in a low-interest rate environment, he sees a place for annuities. That’s because they provide a source of income that won’t behave like other components of a portfolio, including GICs, which must be renewed when they mature at an uncertain future prevailing interest rate.
Annuities, he believes, are an important source of income diversification.
“The best time to buy an annuity is not necessarily when you think rates are high. It’s whenever you need one to achieve financial security,” Mr. Walsh emphasizes. In other words, it’s about timing in a client’s life rather than timing the markets.
No correlation to market ups and downs
Rica Guenther, investment advisor at Wellington-Altus Private Wealth Inc. in Winnipeg, also says the most important context is the client’s life. Regardless of the interest rate environment, she considers annuities when a client is approaching retirement and seeking a guaranteed income stream that can supplement existing pension income without correlation to any market event or volatility.
She adds that annuities can also contribute to tax planning as some structure payments include a non-taxable return of capital.
“A prescribed annuity [in a non-registered account] would be something worth considering for a client [who is] in a higher income bracket and looking to generate income but in a more tax-advantaged way,” she says.
An annuity’s big disadvantage is loss of liquidity. So, especially at times when interest rates are low, Ms. Guenther proposes to income-seeking clients a range of alternatives that preserve liquidity, including dividend-paying stocks and preferred shares. Real estate may also become a more attractive option if interest rates drop and make investment properties more affordable.
Overall, Ms. Guenther sees annuities as complementary to the rest of a client’s holistic wealth plan. It’s another tool advisors can use when a client requires extra guaranteed income to cover a shortfall or plan for longevity.
Certainty of income for a long life
Jonathan Rivard, financial advisor and general partner at Edward Jones in Toronto, suggests annuities may be part of the solution for clients who are hoping for decades in retirement but anxious they will outlive their savings.
“Having certainty of income really matters to clients who are looking specifically for guarantees, clients who may not have an employer-sponsored pension plan … or [clients] who want to know a percentage of their income in retirement is going to be assured,” he says.
That holds true no matter where interest rates settle. Mr. Rivard also emphasizes that adding an annuity to a client’s portfolio depends on that client’s specific circumstances. He adds that what they offer, in a word, is “stability.”
“There can be a lot of reasons assets flow into annuities. For the majority of people, though, who are focused on retirement planning, it’s going to be the certainty that the annuity is able to provide,” he says.
“And with interest rates going up recently, there’s definitely been an increase in the number of clients asking if an annuity is appropriate for them.”
Annuities’ lack of liquidity concerns Mr. Rivard as well, but he says what’s key is setting expectations so clients are very clear about what an annuity can and cannot provide compared with other choices.
He explains to anyone considering an annuity that the reason insurance companies can pay higher rates for annuities, compared to GICs or bonds, is because of that lack of liquidity. Some are very willing to accept that in exchange for getting a higher income stream.
“Being able to anchor themselves in the fact that they do have a portion of their retirement income coming in that’s guaranteed [gives] them confidence,” he says.
“That’s why having a good advisor who is going to go through options and specifically looks at goals, the interest rate environment [and] suitability really matters, so that there’s alignment with expectations, risk tolerance and client confidence.”
