Low Interest Rates: What They Mean for Retirees.
The Fed may have officially raised the prime rate last year, but overall, interest rates remain pretty low. That's great for car or home buyers (4% for a 30-year mortgage, baby!), but it’s not such a blessing for retirees, or anyone relying heavily on investment income (rather than earned income) to get by. The recent buzz about negative interest rates, which haven't hit the U.S. yet (read How Negative Interest Rates Work), makes all this even more unnerving.
If you are living off the interest your assets generate, a low-interest rate environment obviously means less income to live on. What's the plan, then, if you're shopping for income-oriented instruments?
Techniques for Treasuries
The traditional go-to for many retirees are Treasury bonds and Treasury notes, which provide a steady, reliable income stream at a low risk (see Is a treasury bond a good investment for retirement?). But there's a price to pay for the security of an instrument "backed by the full faith and credit of the federal government": T-Bonds and T-notes don't offer the sexiest of yields, and in a low-interest-rate climate, they may not provide much income at all.
What to do? You could try to cash in any bonds you have now, and live off the principal (which precludes any interest income earnings in the future, of course), or opt to invest in slightly higher-risk debt instruments, like corporate or municipal bonds. Another idea: bond-laddering, in which a investor purchases separate securities with different maturities, instead of putting money into a single, long-term bond. So if rates are falling when it's time to reinvest, less of the portfolio has to go into the lower-yielding bonds; if rates are rising, you can get in on the improved yields faster. Read more in Bond Ladders: A Bad Idea for Retirees?
Annuities Angles
Laddering can also be done with annuities, another standby for retirees. Annuities are a type of insurance product that guarantee regular payments (at a either fixed or variable rate) for a designated period or until your death, even if you turn out to be a centenarian.Annuities can provide peace of mind, but they often come with a hefty price tag, in the form of high fees and stiff surrender charges, should you change your mind. Given that, the income they offer in a low-interest-rate environment may not be worth the cost.
Rather than going all in on annuities right now, you could try the ladder technique; or opt for a variable-rate product, which would allow you to benefit when rates start rising again. See How to Buy Annuities When Interest Rates Are Low.
Pension Plan Puzzles
Although they are getting less common, especially in the private sector, employer-based pension plans (officially defined-benefit plans) still exist: Similar to annuities, they can provide a regular monthly income, based on the retired worker's salary history and length of career. These pension funds are invested on the idea that their assets will generate the amount needed to cover their obligations to their pensioners. When interest rates drop, there is always the risk that pension funds may not be able to make their "payroll" – though if that happens, the Pension Benefit Guaranty Corporation (PBGC), which guarantees benefits up to a legally defined limit (sort of like an FDIC for the pension industry), could cover a portion of your monthly stipend.
Since pension plans of this type are pretty much controlled by the employer, individuals' options are limited. Certainly, you shouldn't rely on a pension as the sole source of your retirement income (Grandpa may have been able to, but not you, in today's financial world). Those who are expecting a pension imminently might consider taking it in a lump sum, instead of annuitized payments, and investing it in instruments that offer a better payout (or holding onto the bulk of it, until interest rates improve). See also How Does a Pension Plan Work After Retirement?
Stodgy but Safe Savings
By the time you hit retirement age, you should have some funds put aside in a savings account for that proverbial rainy day. While the current low-interest climate might seem pretty wet, it is important not to move those funds around to try to earn more income. Sure, it's tempting: After all, the interest earned on savings accounts seems even lower than the rates earned on T-Bonds. But emergency funds aren’t designed to dole out a high return on investment, they exist to ensure you don’t go into debt (or worse) should the unexpected happen. If your strategy is to reinvest the savings-account assets, and then use a credit card to cover big emergency costs, consider this: Paying those high APRs on purchases made with plastic is significantly worse than earning even the lowest of rates in your savings account.
The Bottom Line
Low interest rates are generally not great for retirees: No matter how you strategize, your income-oriented investments will feel the pain. But hang on, and try not to decimate savings or dip too much into capital. With luck, interest rates will recover at some point. The plan in the meantime is to do yourself as little damage as possible.
