Managing Post-Retirement Risks: Interest Rates

Lower interest rates tend to reduce retirement income in several ways:

• Workers must save more to accumulate an adequate retirement fund.
• Retirees earn less spendable income on investments such as CDs and bonds; any income reinvested earns lower rates.
• Payout annuities yield less income when long-term interest rates are low at the time of purchase.

Predictability

Long-term and short-term interest rates can vary within a wide range. Underlying forces that drive interest rates include expected inflation, government actions and business conditions.




Managing The Risk

Income annuities provide retirees with a guaranteed fixed income, despite changes in the interest rate environment, but most do not adjust the income for inflation.


Prevailing interest rates will impact the amount of annuity payout the retiree can purchase from a given lump sum.


Investing in long-term bonds, mortgages or dividend-paying stocks also offers protection against lower interest rates, although the value of these investments will fluctuate. The risk is that rising interest rates will reduce the value of such assets available to meet unexpected needs.




Conclusion

Long-term interest rates often move up or down at about the same rate of inflation.


Higher real interest returns, above rates of inflation, usually make retirement more affordable. this occurs when retirees' assets include sizeable amounts of interest-paying bonds, CDs, etc.


However, some retirees have adjustable-rate mortgages or substantial consumer debt, so higher interest rates are an added burden. For such retirees, the higher interest rates that accompany increased inflation may reduce their spendable income just when it's most needed.


Low interest rates in some recent years make it clear that retirees relying on income from interest-bearing investments are subject to interest rate risk.$




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Managing Post-Retirement Risks: Inflation

Inflation should be an ongoing concern for anyone living on a fixed income. In the recent era of relatively low inflation, workers may not know about or remember the double-digit inflation of 1947, 1974 or 1979-81. Even low rates of inflation can seriously erode the well-being of retirees who live many years.

Predictability

Average past inflation can be calculated from historical data, although actual experience over a typical period of retirement may vary widely. Past inflation data can provide some help in estimating retirement needs, but there is no guarantee that future inflation will match historical experience.

Managing the Risk

Many investors try to own some assets whose value may grow in times of inflation. However, this sometimes results in trading inflation risk for investment risk.

Investment returns from common stocks have increased more rapidly than consumer prices in the long run. But in the short term, stocks don't offer reliable protection against inflation. The historically higher returns from stocks are not guaranteed and may very greatly during retirement years.

Inflation-indexed Treasury bonds grow in value and provide more income as the Consumer Price Index goes up. Many experts say that retirees' investments should include some of these securities.

Inflation-indexed annuities, not widely used in the United States, adjust payments for inflation up to a specified annual limit. Annuities with a predefined annual increase also are available. These kinds of annuities cost more than fixed-payment annuities with the same initial level of income.

Investments in natural resources and other commodities often rise in value during periods of long-term inflation, but the values may fluctuate widely in the short run.

Conclusion

Inflation can be a major issue, especially as retirement periods lengthen. Inflation is not highly predictable.

Retirees can set aside assets that will permit a gradual increase in consumption.

Providing for expected inflation one way or another, although costly, is needed in any realistic plan for managing resources in retirement.

Delaying receipt of Social Security will build up valuable inflation-indexed benefits for retirees and spouses.

When housing values were increasing, homeowners seemed to have a hedge against inflation, but this has not been true in recent years.

Current and future retirees who have expected to use their home equity as a source of retirement income may be sorely disappointed, especially if housing values continue to decline. Strategies that rely on increases in the value of housing and selling quickly are very risky, since the value may not rise and it may take a long time to sell the house.$

Next Risk: Interest Rates

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Managing Post-Retirement Risks: Longevity

The past decade has seen not only economic uncertainty and volatility, but also an increased emphasis on individuals taking responsibility for securing their financial well-being in retirement. As a result, today's retirees may be exposed to a variety of risks that can affect them both as individuals and as members of society.

Longevity: Outliving Retirement Resources

Managing one's own retirement funds over a lifetime has many pitfalls, even with expert help. Nobody knows how long the money must last.

Life expectancy at retirement is an average, with some retirees living longer and a few living past 100. Counting on living only to a certain age is risky, and planning to live to the average life expectancy for someone their age will be inadequate for about half of retirees. In theory, retirees want to make sure their money will last a lifetime without cutting back on expenditures or reducing their standard of living. In practice, unexpected events may make this very difficult.

A licensed insurer is the only entity outside the government that can contractually guarantee to pay lifetime income. However, purchasing an annuity involves trade-offs; the household must give up the account balance to purchase the income stream. Financial products from firms that aren't in the insurance business could run out of money to pay income to a long-lived individual.

Predictability

Long lifetimes are difficult to predict for individuals. It's easier to predict the percentage of a population with a long life than to do so for an individual. In the total population, women live longer than men and wives outlive husbands in most cases.

Longevity has increased over time. Any medical breakthroughs could bring additional improvement.

Managing the Risk

Social Security, traditional pensions and immediate payout annuities all promise to pay an individual a specified amount of income for life. In addition, they may also pay income to the surviving spouse or other named survivor. Some newer products can help protect retirees from outliving their assets.

Deferred variable annuities and indexed annuities can include guaranteed lifetime withdrawal benefits that guarantee the availability of annual withdrawals up to a specified amount, even after withdrawals have exhausted the account value.

"Longevity insurance" is an annuity that guarantees a specified income amount but does not start paying benefits until an advanced age, such as 85. This niche product may fit into a carefully designed financial plan.

"Managed payout" plans, offered in several forms by financial services firms, enable the retiree to draw down assets gradually. Lifetime income from such plans is not guaranteed, but is set at a level that provides a high probability that income can be received for many years, e.g., to age 90. In some cases, a "contingent deferred annuity" can be added to guarantee that the income payments will continue for a lifetime.

A Reverse Mortgage can convert home equity into ongoing monthly income as long as the homeowner lives in the home. Administrative charges for these mortgages can be high.

Conclusion

"Payout annuities," also called immediate annuities or income annuities, can be useful for retirees because they maximize the amount of guaranteed lifetime income available from a sum of money.

Some mutual fund companies are offering "annuity alternative" arrangements to ensure liquidity in retirement with cash/mutual fund structures that can be blended with annuities.

An annuity that seems unattractive to buy at retirement age may make sense later. Multiple annuity purchases can be made over time to average interest rates inherent in their purchase prices. People generally should not annuitize all their assets, but they may want to consider annuities in their overall retirement plan.

Financial projections can be very useful in retirement planning , but actual experience will differ. All retirees should review their expected income needs and sources at least every few years and adjust spending if necessary.

Reverse mortgages can help to mitigate risk in some cases, but they may also increase it in others. Care is needed in the use of these products. The mortgage proceeds can be paid in a lump sum, as a monthly income, or as a line of credit.

Annuities and reverse mortgages differ in an important way. When interest rates are higher, you get higher monthly payments when you buy an annuity. In contrast, when interest rates are higher, you get lower monthly payments if you take out a reverse mortgage.

Retired individuals with outstanding mortgages can effectively improve their monthly cash flow by replacing the conventional mortgage with a reverse mortgage, using the lump sum proceeds of the reverse mortgage to pay off the conventional mortgage.$

Next up: Inflation

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