Although low interest rates reduce the amount a retiree is able to safely spend from savings, annuities provide an added lifestyle boost with the potential to provide a higher and safer income than other forms of safe investments such as federally insured CDs, savings accounts, or uninsured bonds.  The increase in safe spending occurs because of so-called mortality credits, which is the benefit provided from sharing the risk of an unknown lifespan with other retirees.  These mortality credits provide a larger percentage increase in spending when interest rates are low.  A retiree concerned about rising future interest rates should consider purchasing a mutual income annuity, which includes the opportunity to receive dividends that will increase income if interest rates increase in the future.

Whole life insurance is a unique financial product that provides competitive tax-deferred growth in cash value over time and the ability to meet a range of financial needs including legacy, income, and emergency spending needs.  The smoothing of cash value growth means that the cash surrender value available in a whole life policy will not fall in value if interest rates rise in the future.

Income Annuities and Low Interest Rates

Retirement expenses can be funded using less volatile investments such as bonds or through risky assets like stocks.  Investment risk simply means that future returns are uncertain. A bond will provide greater spending certainty and a stock return is less certain.

A retiree should begin the retirement planning process by deciding how much income is needed to pay for essential spending categories such as health care, food, property taxes, insurance, and utilities. These expenses should only be funded using investments whose value does not fluctuate widely over time.  Most families are not able to cover all their desired safe retirement expenses using Social Security, so they must devote a portion of their retirement savings to creating a safe, base income.

There are two ways to fund a base income using bonds.  The first and most common method is simply to invest in safe assets through a bond mutual fund, money market fund, or a savings account, and then to withdraw money from savings every month to fund basic expenses.  Many retirees simply use their savings accounts, as well as required minimum distributions from an Individual Retirement Account (IRA), to pay for these fixed retirement expenses.

The second way to fund safe spending is through an income annuity. Income annuities are simple financial products created for the purpose of providing a dependable lifetime income. Annuitization involves combining (or pooling) savings among retirees. These pooled savings are invested by an insurance company and the original savings and interest are returned to retirees as lifetime income.  In order to receive the benefits of higher and safer income provided by annuitization, these savings are held by the insurance company (they are not liquid) to ensure that income payments can be made to all surviving annuity owners. 

Most families already own a form of income annuity through Social Security or a pension. In the absence of an employer pension, today’s retiree accumulates savings in a 401(k) and eventually an IRA. The purpose of a retirement account is, therefore, to fund a lifestyle. An income annuity allows a retiree to buy a predictable lifetime paycheck from their retirement savings.

However, using safe savings to pay for basic retirement expenses is more expensive today than it has been in the past.  This is because interest rates on savings accounts, and yields on bond investments within in an IRA, are at historical lows.  Low interest rates are not a new phenomenon.  In the United States, interest rates on less volatile investments have been falling for the last thirty years and have been well below the historical average for a decade. 

Figure 1 shows the average 1-year yield on a safe Treasury Bill investment.  Interest rates on most safe savings accounts will be near the yields on Treasury Bills. 

one-year yields

Data Source: Federal Reserve Bank of St. Louis. Past yields on Treasury Bills are not a guarantee of future yields.

Do Low Interest Rates Make Income Annuities More or Less Attractive?

When a retiree pays for fixed expenses using retirement savings, the amount they can withdraw depends on a) how much money they have saved, b) how many years of spending they hope to fund, and c) the interest rate on their savings.  When interest rates are low, this reduces the amount of income that can be produced each year from safe investments.

To understand the impact of interest rates on a lifestyle in retirement, consider a 65-year-old female retiree who has saved $250,000 to fund fixed expenses in retirement. She hopes to fund safe spending to an age at which she has only a 10% chance of outliving her assets. According to mortality tables, which are created by statisticians to predict expected longevity, a healthy female will need the money to last until age 1001.

What is the lifestyle difference between receiving 6% interest on savings versus a 2% interest rate? Figure 2 compares the amount that a retiree can spend each month in a low interest rate as opposed to a higher interest rate environment.  The difference is striking.  With 2% interest, she can spend $828.  With 6% interest, she can spend $1,425.  Although the interest rate difference sounds modest, spread over 35 years the retiree’s safe income drops by 42% per month when interest rates fall by just 4%. 

Figure 2: Monthly income from a 35-Year $250,000 investment earning 6% and 2% interest.  

income graph

Over the 35-year time period, at a 6% rate of return the retiree earns a total of $348,699 in interest, which explains why the retiree can spend $1,425 per year. At a 2% rate of return, she earns just $97,826 in interest over 35 years. Earning less interest on savings means a lower average lifestyle.

Does a retiree in a low interest rate environment have other options to fund safe spending? After all, today’s retiree saved in a mix of stocks and bonds within a traditional 401(k), and these less risky bonds are meant to fund a range of retirement goals that often include a stable income to pay for lifestyle expenses. It is possible to use some of these safer investments to meet the goal of lifetime income more effectively through an income annuity.

Income annuities can provide a monthly income that may be both higher and safer than using bond investments alone. Income annuities provide interest on less volatile investments and contribute mortality credits that can boost her lifestyle. Mortality credits are the increase in expected income received from combining savings with other retirees that are used to fund lifetime income.  Setting aside enough money to fund spending to an age when only 10% of retirees is still alive is inefficient.  By combining (or pooling) savings with other retirees through an insurance company that can predict longevity, it is possible to receive a lifetime income guarantee that is higher than one could achieve without the benefit of risk pooling.

To understand why economists consider the failure to annuitize a puzzle, let’s consider the value of mortality credits to a retiree. I’ll use an average of the top 5 actual quotes2 from insurance companies on a single premium immediate annuity (SPIA) that has a 20-year period certain income payment. The period certain option means that even if the retiree does not live 20 years in retirement, their children (or another beneficiary) will continue to receive the income payments until 20 years of payments are made. An immediate annuity starts making payments the month after it is purchased for a single premium, in this case $250,000.

Annuities require that the retiree pays the annuity premium up front to receive the lifetime income guarantee. This is the tradeoff that is required to receive higher, safer income through mortality credits that only exist when individuals pool their premium dollars with other retirees in the form of an income annuity to be managed and distributed as lifetime income through an insurance company.

Figure 3: How mortality credits provide additional monthly income from a $250,000 annuity.


On February 28, 2022, a Treasury bond portfolio used to fund income until the age at which a 65-year-old female has a 10% chance  of outliving her savings provided $824 per month3, of which $595 was a return of principal and $229 was interest. Figure 3 shows that a retiree could purchase a $250,000 income annuity that would provide an additional $332 in monthly income through mortality credits.  By pooling her savings with other retirees through an insurance company, the retiree could increase her monthly income by 40%.  In addition to receiving a higher income, the insurance company agrees to continue making income payments even if she lives beyond age 100.  Taking a portion of retirement savings to buy income through an annuity can potentially improve the retiree’s lifestyle while reducing the risk of outliving her bond investments.

Annuitization becomes even more important in a low interest rate environment because mortality credits have more power to increase income. A bond investment provides income only through a return of the original investment and interest.  When rates are low interest makes up only a small portion of each dollar spent on income and the mortality credits make up a larger share of the income payment. 

Figure 4 shows how much of an income boost a retiree receives from annuitizing in various interest rate environments. Estimates are based on a fairly priced income annuity for a 65-year-old woman. As interest rates fall from 6% to 1%, the percentage improvement in monthly spending from annuitization increases from 21.5% to 39.3%.  Since the mortality credit is unaffected by interest rates, it becomes even more important in a low interest rate environment.

Figure 4: Increase in income from annuitization relative to bonds for a 65-year-old woman

annuity income boost

Fairly priced annuity based in SOA mortality tables

In a low interest rate environment, income annuities give retirees an opportunity to increase the amount of base income that can safely fund essential spending. Rather than paying for expenses through a savings account or bond investments, an income annuity gives a retiree a monthly paycheck they can use to freely spend without the fear that their savings will run out if they live too long.

Whole Life Insurance and Low Interest Rates

The primary purpose of a whole life insurance policy is to create lifetime insurance protection. When a family is young, the policy helps protect against the loss of a breadwinner. Later in life the whole life policy provides an efficient means of transferring wealth to loved ones, and can provide a source of emergency cash or even lifetime income depending on needs and circumstances.  The mature whole life insurance policy provides flexibility to meet a range of household financial goals.

In Figure 5, the orange line shows the growth in cash surrender value of a whole life policy purchased in 1986 by a 35-year old female.  By the end of 2018, the whole life policy provided 33 years of insurance protection while accumulating cash value over time. A whole life policy is a financial product that accumulates cash value slowly early in the life of the policy and more rapidly as the policy matures and the initial costs of creating and distributing the product are paid. Growth in cash value is smoothed artificially by the insurance company so that it never decreases in value and provides predictable long-term growth.

The blue line represents the growth in cash (specifically 3-month Treasury bill rates) that are similar to rates received on a money-market savings account or a CD.  This represents the wealth impact of “buying term and investing the difference” in a taxable savings account.  Of course, tax-deferred savings accounts such as a 401(k) provide tax-efficient savings, but many households also accumulate wealth in so called non-qualified accounts outside of their defined contribution plan that are less tax efficient over time.  The annual premium on the $100,000 death benefit whole life policy is $1,303.  Each year the individual buys a term policy to provide needed life insurance protection and place the difference between the whole life premium ($1,303) and the term life premium ($146 at age 35) into a savings account. 

In 1986, the term life insurance buyer was able to place $1,157 that she would have spent on a whole life premium in a savings account that earned 6.2% interest in 1986.  She earned $71 in interest and paid $17.75 in taxes at a 25% combined marginal federal and state tax rate, giving her a total of $1,210.5 at the end of the year. The second year she places an additional $1,149 in the savings account and buys another 1-year term insurance policy.  By 2019, her savings account holds $28,205 compared to $96,790 in cash surrender value in the whole life policy.

Excess premium payments that create cash value are invested by the insurance company in the general account portfolio of the  insurance company.  The general account consists of a range of financial instruments, the bulk of which are bond investments whose duration (term) matches that of expected future obligations.  One important difference is that the growth rate on cash value is smoothed to provide much lower volatility than the growth on an investment in intermediate-term bonds.

The yellow line shows the growth in an investment in intermediate-term bonds for an individual who buys a term life insurance policy and invests the whole life premium difference in an intermediate-term bond index.  I assume total investment fees of 1%, which is below the average expense ratio on mutual funds during this time period, as well as a tax rate of 25% on gains (with losses fully offsetting income at 25% during down years). By 2019, the bond funds grew to $75,893.  This amount is still lower than the $96,790 accumulated cash value, primarily because the cash value growth was not taxed annually. 

Figure 5: Growth in Life Insurance Cash Value and Equivalent After-Tax Growth Buying Term Insurance and Investing in Bonds

growth in life insurance cash value

Source: Morningstar SBBI Treasury bill and Intermediate-term treasury index.

If the family chose to liquidate the cash value policy at the end of 2019, the original premium payments would be untaxed ($44,302) and the growth ($52,488) is taxable at the 25% income rate.  This leaves the family with $83,668 net of taxes.  This amount is still higher than the total amount in the intermediate-term bond fund net of taxes.  However, the cash value will continue to grow tax deferred through retirement resulting in a highly efficient transfer of wealth to beneficiaries for those who hope to pass on a legacy.  A family that prefers income can annuitize the cash value without paying immediate taxes on the cash value through a so-called 1035 exchange.

There are two additional advantages of cash value that are significant to retirees in a low interest-rate environment today.  The first is that the cash value grew to $96,790 at the end of 2019 from $91,311 at the end of 2018.  This growth rate of 6.0% in cash value far exceeds the yield on high quality bonds in 2019.  This growth is also free of income tax.

The second advantage of cash value is that a sharp rise in interest rates will not result in a decline in savings.  For example, in 2013 the intermediate-term bond fund fell by 3.7% causing a loss of nearly $1,000 in the total savings that year even after adding the whole life premium payment. Cash value within the whole life policy grew by $4,268 that year, a 6.3% increase.  The next year cash value grew by 6.4%. Because the insurance company smooths returns over time among policyholders, an investor is not exposed to the same annual volatility in cash value as they are in a comparable bond fund. This reduced volatility can provide considerable peace of mind to a retiree that fears the portfolio risk of rising interest rates.


Although low interest rates reduce the amount a retiree is able to safely spend from savings, annuities provide an added lifestyle boost through mortality credits that result in a higher and safer income than other forms of safe investments.  Mortality credits provide a larger percentage increase in spending when interest rates are low.  A retiree concerned about rising future interest rate should consider purchasing a mutual income annuity which includes dividends that will increase income if interest rates increase in the future.

Whole life insurance is a unique financial product that provides competitive tax-deferred growth in cash value over time and the ability to meet a range of financial needs including legacy, income, and emergency spending needs.  The smoothing of cash value growth means that the cash surrender value available in a whole life policy will not fall in value if interest rates rise in the future.

Media contact
Kevin Maher
New York Life Insurance Company
(212) 576-6955

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1 According to Society of Actuaries annuity mortality tables.
2 Quotes drawn from CANNEX on February 28, 2020.
 Assumes a Treasury bond yield curve as of June 5, 2020. Source