Annuity rates are high thanks to bond-market turmoil

Income-annuity payout rates are at generational highs.

Bad news is sometimes good news. And the recent bad news from the turmoil in the bond market - which has seen long-term interest rates rising to multidecade highs - is also good news for those nearing or in retirement.

That's because those long-term bond rates have also driven the payout rates on new lifetime annuities to their highest levels in a generation.

If you're among the 11,000 Americans turning 65 today - or even if you aren't - this is important retirement information you should know.

A woman retiring today at age 65 can spend $100,000 to secure a guaranteed income for life of $650 a month, or $7,800 a year, by purchasing a single-premium immediate annuity from an insurance company. A man of 65 can secure an income of $675 a month, or $8,100 a year.

To give you an illustration of how far these have risen, according to data from ImmediateAnnuities.com, about five years ago - when interest rates were around their post-COVID lows - the same annuity would have secured the woman an income of just $450 a month, and the man about $470.

Those rates were abnormally low. Today's rates are high by the standards of recent history. But whether they will get still higher is a question for the bond market. If it tells you, let us know.

Immediate annuities could be better described as do-it-yourself pensions. They are products from life-insurance companies, backed by bond portfolios and strictly regulated by state governments, which convert a pile of money into a guaranteed lifetime income. Given the amount we keep reading about the (mythical) "golden age" of pensions - when most people supposedly enjoyed defined-benefit, final-salary-type pensions - you'd think immediate annuities would be more popular than they are.

Instead, sales of these "single-premium immediate annuities" are trivial: just $4 billion in the second quarter, according to insurance-industry trade association Limra. That's out of a total sales of all insurance products labeled "annuities" of $124 billion.

Part of the problem may be the name. Income annuities - mainly these single-premium immediate annuities - are very different products from all the other things that the insurance industry calls "annuities," such as "index-linked" and "variable" annuities. Most of those are savings products produced by insurance companies that are typically designed for accumulating savings, not spending them. Many of them, with good reason, have earned a questionable reputation for complexity, high fees and sometimes costly lock-in periods.

Income annuities, by contrast, are relatively straightforward: They act as a kind of life insurance in reverse. Or, if you like, as a reverse mortgage on your life, instead of your house. The insurance company, using bond yields and actuarial tables, works out what sort of interest rate it can pay on average to a large pool of customers of a particular age. The older you are when you buy an annuity, the higher the return because your remaining life expectancy is lower. (This is also why annuity rates are typically slightly higher for men than for women, because men, on average, die younger.)

Nothing in life is free, and in return for their guaranteed income, annuities come with three costs.

The first is that when you die, there is nothing left over for your heirs - that is how insurance companies can afford to offer higher payout rates than you can get from a traditional investment portfolio.

The second is that when you buy an annuity, you lose liquidity: You get the monthly income, but you lose control of the capital. If you need a big lump sum, you won't have access to the cash.

The third is that a typical annuity generates a fixed income. The longer you live, the more you are at the mercy of the effects of inflation.

The only annuity available with a nearly rock-solid inflation adjustment is Social Security. But in the private sector, you can get some protection by purchasing annuities that start with a lower initial payout and then raise those payouts each year by a fixed amount.

The Federal Reserve says it is still targeting inflation rates of 2% a year. If a 65-year-old woman wants an annuity that raises its payouts each year by 2% to keep up with that notional target, right now, in exchange for $100,000, she'd get an initial monthly income of $540 a year, for a payout rate of 6.5%. (A man would get $575 a month, for a payout rate of 6.9%.)

I typically use this figure, for annuities with a 2% annual adjustment, as the simplest comparison with the so-called 4% rule.

If you are suspicious of the Federal Reserve and that 2% target despite the recent protests from new Fed Chairman Kevin Warsh (and you may not be alone), you might want to give yourself more of a buffer. A $100,000 annuity right now with a 3% annual increase would start with an initial payout rate of 5.9% for a woman or 6.3% for a man - equal to monthly incomes of $490 and $525, respectively.

Five years ago, they'd have been lucky to get $310 and $330 a month. Really.

According to ImmediateAnnuities.com data, today's rates beat those available pretty much throughout this millennium, apart from a brief period during the 2007-09 financial crisis when bond yields rocketed. You'd have to go back to 1995 or earlier, when inflation and bond yields were typically far higher, to find a time when similar or better annuity rates than today were standard.

A general rule of thumb in the finance industry is the so-called 4% rule, which says that when you retire, if you keep your savings in a balanced portfolio of stocks and bonds, you should be OK in retirement if you withdraw no more than 4% of your portfolio's value in the first year. If you stick to that, raising the amount you withdraw every year by no more than the rate of inflation, you should be certain of outliving your savings.

That's based on history, and it is not guaranteed. There are also complicating factors such as so-called sequence-of-return risk, which refers to how the outcomes vary depending on whether a bear market in stocks hits soon after you retire. And these calculations often assume you live for a maximum of 30 years.

There are no perfect solutions, but annuity payout rates today comfortably beat 4%. If you are really, really skeptical of the Fed, a few insurance companies even offer income annuities that lock in an annual increase of 5%. Right now, those have initial payout rates of 4.5% for a 65-year-old woman and 4.8% for a man, also well ahead of the 4% rule. (Or, to put it another way, a 65-year-old woman with $100,000 can secure an initial retirement income of $375 a month, and it will rise by 5% every year thereafter. For a 65-year-old man, the initial payout would be $400 a month.)

As annuity payout rates are based on the interest rates on corporate bonds, it is impossible to know whether they will head still higher. But they offer a potential solution to the retirement-income issue that more retirees should consider.

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-Brett Arends