#3 Financial Risks—Interest Rate Risk
Lower interest rates minimize retirement income by lowering growth rates for savings accounts and assets. As a consequence, people may need to save more money in order to have the adequate retirement funds. Annuities provide less income when long-term interest rates at the time of purchase are low. Low real interest rates will also cause purchasing power to erode more quickly.
“In today’s interest rate environment, an annuitant is locking in a payout based on today’s interest rates. The interest rate used for calculating your payout will be in the 2% range. The question to ask is, ‘Are you really willing to lock in that low an interest rate for the rest of your life?’” says William DeShurko, chief investment officer, Fund Trader Pro, LLC, Centerville, Ohio.
A reduced retirement income is really risky especially when people are dependent on drawdown from savings to finance their retirement. However, another serious issue could be just around the corner if interest rates rise, as the market value of bonds drops.
“With interest rates so low, retirees need to understand the impact higher inflation and rates will have on their bond investments. Bond prices move inversely to interest rates. For example, if a bond has a duration of seven years and rates jump 1% higher, they could see the value of their bond fall by about 7%,” says Dan Timotic, CFA, managing principal of T2 Asset Management in Oakbrook Terrace, Ill.
There’s a never ending list of negative things when it comes to interest rates. Increases in interest rates can also impact the stock market and the housing market, therefore affecting the retiree’s disposable income.
