The Federal Reserve on Wednesday raised the federal funds rate for the second time in 2018. That’s good news for millions of diligent American savers, especially those in retirement.
After the short-term interest rate increase, some banks and credit unions bumped up the yields tied to their certificates of deposit (CDs) and savings accounts. Additional financial institutions could follow suit in the coming months.
Here are five reasons Fed rate hikes benefit retirees.
1. The promise of better returns on savings
Rates on deposit accounts have been low for quite some time. The target range for the federal funds rate is currently 1.75 percent to 2 percent. But nearly a decade ago during the financial crisis, the Fed lowered it to a range of 0 percent to 0.25 percent.
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.”
Interest rate hikes give retirees something to look forward to, particularly if they’re keeping a large percentage of their cash in CDs and savings accounts. And rising rates prevent retirees from having to rely on sources of income that are less liquid.
“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,” says Alan Moore, a financial planner and co-founder of the XY Planning Network in Bozeman, Montana.
2. Better rates on fixed annuities
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 says. “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 higher.
“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, Moore says. Plus, buying annuities from separate companies protects you if one of them goes bankrupt.
3. Help for underfunded pension funds
Pension funds have been in big trouble. Out of 103 state pension plans, 97 percent were underfunded, according to a report published by Wilshire Consulting. In order to cover future liabilities, pension funds’ assets must grow at an adequate pace. Low interest rates have made that goal difficult to achieve.
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.
4. Help for costly long-term care premiums
Long-term care insurance covers the cost of a wide range of 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.
5. Protection from future inflation
A surge in prices would easily overwhelm the returns retirees get from CDs, savings accounts 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 1980s, the Fed was forced to crank up rates 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 (TIPS), which increase your principal in tandem with rising inflation.