June 12, 2017 in Federal Reserve

6 reasons retirees love it when the Federal Reserve raises interest rates

The Federal Reserve meets this week and is likely to raise the federal funds rate for the second time in 2017. That’s good news for millions of diligent American savers, especially those in retirement.

CDs and savings accounts will offer higher rates, but the increase won’t be immediate and you’ll have to shop around for it, says Greg McBride, CFA, chief financial analyst for Bankrate.

“Those top-paying yields now are likely to keep on paying competitive yields, even as rates rise.”

Here are six reasons retirees are in favor of the Fed pushing rates higher.

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The Federal Reserve lowered the federal funds rate to a range of 0 percent to 0.25 percent in December 2008. The central bankers have raised it three times since, most recently in March 2017 to a range of 0.75 percent to 1 percent.

Rates on certificates of deposit (or CDs), money market accounts and savings also have stayed low.

The result has been devastating for retirees counting on safe, fixed returns, says Michael Rubin, founder of Total Candor, a financial planning education firm based in Portsmouth, New Hampshire.

“They’re earning a lot less on their savings than any other time in recent history,” says Rubin, author of “Beyond Paycheck to Paycheck.”

However, even getting a 1 percent return has been preferable for retirees, says Alan Moore, a financial planner and co-founder of XY Planning Network in Bozeman, Montana.

“When the stock market takes a dive, (retirees) don’t want to be in the position of having to sell stocks to fund their lifestyle,” he says.

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Low rates undercut the strategy of using an annuity for a safe income stream, Moore says.

“The monthly income a client receives from their fixed annuity is based on interest rates at the time they purchase the annuity,” he explains. “With interest rates at all-time lows, annuity payouts are also at all-time lows.”

Moore has been urging investors to avoid annuities until rates climb.

“Another option is to buy a smaller annuity today, such as 25 percent of what (investors) would normally buy,” he says.

Doing this several times from different companies over a few years allows you to buy at various interest rates, he says. Plus, buying from separate companies protects you if one of the companies goes bankrupt.

Pension funds have been in big trouble. Ninety-three percent of corporate defined benefit pensions were underfunded in 2015, according to Wilshire Consulting.

Pension funds must make sure their assets grow at a pace adequate to cover future liabilities. An earlier Wilshire report noted that low interest rates have made that goal difficult to achieve.

“It is putting pressure on the already-weak pension system,” Scott says.

Rubin says that current pension recipients have been unlikely to see their payouts cut. Future retirees may not be as lucky, he says.

Moore agrees, and says workers who are worried about their company’s pension plan must take action now. “They need to save more or work longer, as well as delay Social Security, to maximize the benefit they will receive,” Moore says.

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Long-term care insurance covers the cost of a wide range of expensive services you may need in your final years, including nursing care, assisted living and adult day care. This insurance potentially can save you and your family hundreds of thousands of dollars.

But because of lower interest rates, long-term care insurance premiums have skyrocketed, says Jesse Slome, executive director of the American Association for Long-Term Care Insurance.

“Lower rates have wreaked havoc on long-term care insurance costs,” he says.

As interest rates fell, insurers saw the return on their investments slip. For every 1 percent decline in rates, insurers have needed to hike premiums by 10 percent to 15 percent, according to Slome.

Consumers may have been tempted to delay buying long-term care insurance while they wait for interest rates to rise. But that strategy has carried risks.

“Twenty-four hours from now, your health can change,” Slome says.

Many retirees are risk-averse and prefer to park a good percentage of their cash in “safe havens,” such as savings accounts and CDs. Low returns have forced many of these older Americans to wade into the more turbulent waters of the stock market, Scott says.

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Other retirees have been buying bonds in the belief they are safer than stocks. That means Fed policy may have fostered a bubble in the bond market that will burst once rates return to normal.

“For 30-plus years, bonds have been safe, and this seems ingrained in the minds of people,” Scott says. “But with a rise in rates, these safe assets will lose value.”

The Fed’s policy of keeping rates low was meant to make borrowing less costly and, thus, stimulate the economy. But all that “cheap money” has come at the risk of potentially setting off inflation somewhere down the road.

A surge in prices would easily overwhelm the returns retirees get from CDs, savings and other fixed-income investments.

An increase by the Fed in its federal funds target rate is the best way to tamp down incipient inflation.

Once inflation starts, it can be difficult to stop. In the early 1980s, the Federal Reserve was forced to crank up rates to a high of 20 percent before it got inflation under control.

Moore has urged investors who fear future price increases to keep some of their bond portfolio in Treasury inflation-protected securities, or TIPS, which increase your principal in tandem with rising inflation.

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