With ultra low interest rates having driven down annuity payouts, clients may be reluctant to lock into annuities in the current environment. When considering the rock-bottom rates on alternative fixed-income investments, however, experts say advisors should not overlook annuities as a viable option for clients.

“Today, annuities are still a pretty good deal, when you compare them to a typical alternative,” says Peter Wouters, director of tax and estate planning with Toronto-based Empire Life Investments Inc. “For the typical customer who’s looking at annuities, the alternative is a term deposit…it’s all that low interest-paying stuff.”

Annuities pay rates that are substantially higher than other fixed-income instrument because the payouts are comprised of both interest and the client’s original invested capital.

A 65-year-old male client who buys a $100,000 annuity today, for instance, could expect to receive payments of about $7,000 a year for the rest of his life. In contrast, that client would earn little more than 2% on a 10-year guaranteed investment certificate (GIC).

Similar to other fixed-income products, however, annuity payout rates are highly sensitive to changes in interest rates, and thus, they’re far lower than they were before interest rates plummeted.

As a result, some advisors consider annuities unappealing in the current environment.

“With interest rates being as low as they are now, it’s kind of tough to make annuities work,” says Earl Siegle, insurance advisor with Siegle Financial Group Ltd. in Westlock, Alta.

Whereas Siegle sold annuities fairly often when interest rates were higher, he says he has sold far fewer since rates have retreated. Given the permanent nature of annuities, he says it’s critical to ensure clients are completely satisfied with the rate they’ll be getting.

“If you buy an annuity in a low interest rate environment, you’re stuck with it,” he says. “If you want to get out of it, you’re handcuffed.”

Siegle says he’ll likely give annuities more consideration once interest rates rise.

However, clients and advisors who wait for rates to rise could find themselves waiting far longer than they expect, as rates don’t appear likely to move up in the near future, says Bruce Cumming, executive director, private client group, and senior investment advisor with HollisWealth Inc. in Oakville, Ont. Even if short-term interest rates begin to rise, he notes that annuity payouts won’t necessarily improve right away.

“Long bond rates need to move up before annuities are going to look better,” he explains. “There’s no guarantee that when short-term rates will go up, long term rates will match them.”

Some individuals have been holding off on buying an annuity for more than five years, having anticipated that interest rates would have moved higher by now. Had they simply bought the annuity five years ago, Cumming says they would likely be much farther ahead by now, considering the low returns they’re earning on alternative fixed-income investments.

Another problem with waiting is that although an increase in interest rates will improve payouts on annuities, it will have a negative impact on the value of clients’ existing fixed-income holdings.

“When interest rates go up, the value of bonds goes down,” says Cumming. “So, they’re going to end up with less money when interest rates go up, and they’re going to have less money to buy the annuity. So, now, before interest rates go up, is the most important time to be buying an annuity.”

Clients who are reluctant to lock down all of their assets in the current environment could put a portion of assets into an annuity now, followed by another portion in five or 10 years. This laddering approach offsets the risk of buying an annuity at a time when rates aren’t optimal.

“That’s going to give them some protection,” says Wouters.

This is the second article in a three-part series on annuities.

On Thursday: Alternatives to annuities.