How Changing Interest Rates Affect Retirement

Interest rates affecting retirement


The ongoing low interest rate environment that the U.S. economy has experienced over the past few years has presented unique challenges for some retirees who are dependent on a stream of interest income from investments to meet their everyday living expenses. This is because low interest rates generally result in lower yields (or returns) on fixed-income investments.

“Only time will tell what is going to happen to interest rates in the future, although most experts agree that rates will eventually rise since they are at or near historic lows,” says David Lerner Associates Executive Vice President Martin Walcoe. In fact, when Federal Reserve Chairman Ben Bernanke recently announced that the Fed might possibly reduce the pace of its bond purchases at some time in the future — which, in turn, could result in higher interest rates — bond prices fell sharply, which drove up yields.

The Tradeoff

Walcoe notes that many retirees prefer to invest a high percentage of their assets in relatively safe fixed-income instruments like certificates of deposit (CDs), money market accounts and bonds. “With this safety, however, comes a possible tradeoff: low yields and less income. But as interest rates rise, retirees’ income may rise along with them.”

But how much impact do interest rates really have on an individual’s ability to retire comfortably? Two different retirement research firms have recently come to different conclusions.

According to the Center for Retirement Research (CRR), the link between higher interest rates (and thus higher income) and retirement security is relatively weak. “Changing interest rates has only a modest effect on the NRRI,” the CRR stated in a report. The NRRI, or National Retirement Risk Index, tracks the shifting odds that Americans will be able to maintain their pre-retirement living standards in retirement.

Though the CRR says the retirement adequacy of more than half of all workers is at risk in today’s low-rate environment, this would still be the case even if rates returned to historically normal levels. “Regardless of the interest rate, today’s workers face a major retirement income challenge,” the report said. The CRR concluded that interest rates don’t affect retirement outcomes because “interest rates do not play a role during the asset accumulation period.”

Another Viewpoint

Conversely, the Employee Benefit Research Institute (EBRI) has found that changing interest rates have a substantial impact on retirement adequacy. EBRI’s model differs from the CRR model in several key ways. For example, it does not assume that retirees will annuitize their assets when they turn 65, but that they will spend Social Security and pension income and then withdraw additional money from 401(k)s and IRAs as needed. If they run out of money, it assumes they will convert their home’s equity into a lump-sum distribution to acquire more funds.

EBRI determined that if interest rates rise back to historical averages, about half (55 to 57 percent) of baby boomers and Gen Xers will have enough retirement resources to cover all of their simulated retirement expenses. However, the percentage falls when lower interest rate assumptions are used.

Assuming the actual interest rates from recent years, for example, the retirement readiness percentage drops by 15 percentage points for those with between one and nine years until retirement, 21 percentage points for those with between 10 and 19 years until retirement, and 22 percentage points for those with 20 or more years until retirement.

EBRI notes that those with lower incomes are least affected by changing interest rates. This is because they depend more heavily on inflation-adjusted Social Security benefits for their retirement income, which are not affected by changing interest rates.

Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities. Member FINRA & SIPC.


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