The Upside of Low Interest Rates for Retirees
February 16, 2016 | Enjoying Retirement
In late 2015, the Federal Reserve raised its benchmark interest rate for the first time in nearly a decade. After years of earning next to nothing on savings, the rate increase—albeit a small one—signaled a potential turning of the tide.
And while the .25 percent interest rate hike has been widely viewed as an important signal that the economy is getting back on track, some economists caution that the process of raising rates to significant levels will be a slow and deliberate one, with rates remaining historically low for at least the next 12-18 months. So in the short term, that means thousands of Baby Boomers will continue to retire each day into an environment in which CDs, money market and savings accounts still don’t earn much interest. And if they haven’t considered the potential impact of lower rates on their retirement income, they may need to cut back on their spending.
But a lower interest rate environment isn’t all bad news for the newly or soon to be retired. There is a bright side.
1. If you have debt or plan a major purchase in retirement, the still-low interest rates could work in your favor. Nearly one-third of homeowners ages 65 and older still carry a mortgage, according to the U.S. Census Bureau. If you’re one of those who is in (or heading into) retirement with a mortgage, one option is to refinance the balance if today’s rates are lower than the interest rate on your current loan. If you can reduce your monthly payments or pay off your mortgage earlier, you’ll free up additional dollars that can help to offset the lower interest you may be earning on your bank accounts.
A second option is to hold onto your mortgage (and its potential tax-deductible interest), especially if you’re already paying a low interest rate. In that case, any additional dollars you may have earmarked to pay off your mortgage early could instead be invested in the market or could be used to purchase permanent life insurance, which in addition to providing a death benefit has cash value that grows over time.
And if you’ve been thinking about making a significant purchase, such as a new car or a retirement home, today’s still-low interest rates may make those goals more achievable.
2. Inflation remains low. Not only have interest rates been low, so has inflation. The annual rate of inflation in 2015 was at 0.5 percent, its lowest point since 2008. What does that mean for retirees? If you factored in a standard rate of inflation such as 2, 3 or 4 percent as you saved for retirement, the dollars you do have will, for now, stretch a bit further than you may have expected.
3. Some of today’s most innovative financial products are designed to provide value in both high and low interest rate environments. You may not think an annuity would make sense in a low interest rate environment; who wants to lock in low interest rates for life? But some of today’s annuities offer features and benefits unheard of just a decade ago that make them viable options for retirees and pre-retirees who want to create guaranteed lifetime income—even in a low interest rate environment.
Variable annuities are one example. Instead of being tied to a fixed interest rate, they are tied to the performance of underlying investment options chosen by the individual. The value of a variable annuity can go up or down and, similar to other investments, is subject to market risk, including potential loss of principal.
Other types of annuities, such as income annuities, do not accumulate wealth or have a cash value; rather, they’re specifically designed to provide guaranteed income for life. But, certain income annuities have the potential for dividends, which can be taken as cash distributions, used to increase lifetime income payments or a combination of both. And finally, with some income annuities, you can choose to receive a lower initial payment and have payments increase each year by a certain percentage.
Low interest rates aren’t necessarily bad news, but they do need to be considered as you develop a plan to save for and create income in retirement. That’s why it’s important to work with a financial professional: Ask him or her to test-drive your retirement plan against various interest rate and inflation scenarios to see how it’ll hold up under different circumstances. With that knowledge, you can take steps to reach your retirement savings goals, regardless of the economic environment.
Annuities are offered by life insurance companies and generally considered as long-term financial products that may be suitable for retirement. It’s important to note that all guarantees associated with annuities are backed solely by the claims-paying ability of the issuer; however, guarantees do not apply to the performance of the investment options in a variable annuity. Variable annuities carry various fees and expenses, and all annuities may be subject to ordinary income tax, a 10 percent IRS early withdrawal penalty if taken before age 59½ and contractual withdrawal charges.