The Federal Reserve announced recently that its target federal funds rate is now between 0% and 0.25% to help during the COVID-19 financial crisis and they have come out recently to say they have a long term plan to keep the rates at similarly low levels. These low rates are going to make annuity rates drop as well.
What Fed Rates Do
The federal funds rate, or fed rate, changes the money supply of the American economy, but what does that mean for Americans? When the federal funds rate changes it can make it cheaper or more expensive to borrow money. It also makes the interest rates returned by securities, such as bonds, to go up or down. When the federal funds rate is high it encourages investment in government fund options. However, when it is low it encourages borrowing money to encourage people to start businesses and stimulate the economy.
Since the economic downturn caused by the pandemic is still impacting the nation, the Federal Reserve pushed rates even lower than they were before. The rates were already very low for quite some time, so they have been pushed to nearly 0%.
What Does This Mean For Annuity Rates?
Before discussing what federal funds rates do to annuity rates it is important to understand the major types of annuities.
- Fixed Annuities: guarantee the purchaser a set rate of return on their money regardless of what the market does during the period. Fixed annuities are simple and low risk but lack the potential upside if the markets do well.
- Variable Annuities: annuities tied to a portfolio of stocks, bonds, and money market funds and are the most like a regular investment. Variable annuities vary more than a fixed annuity but have a higher potential upside.
- Indexed Annuities: the interest rate it returns is tied directly to a stock index like the S&P. Indexed annuities are riskier than a fixed annuity but have the potential to do better if the markets do well like a variable annuity but with less variability.
When the federal funds rate drops, so do the interest rates offered for fixed annuities. Although they are slow to react since their rates are stable. This is due to the guaranteed safety offered by the federal reserve investment vehicles. However, once a fixed annuity has its rate set it does not change. So there is still an opportunity to lock in a higher rate on a fixed annuity before the fed pushes the rates lower than they are now. Indexed and variable annuities, on the other hand, could be influenced by the effects rate cuts have on the market.
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