New Rules In Retirement

Standing up to a changing interest rate environment

by Michael S. Ross

Over the last few years and for the first time in many investors’ lifetimes, the current interest rate environment is creating meaningful opportunities for clients. There was once a time when someone could retire at 65, put their money in a CD and be fine. While today’s higher interest rates have made those investments more attractive again, longer lifespans mean that approach is no longer enough.

People retiring today have a longer investment timeframe than the parents of newborn children saving for college and you likely wouldn’t recommend a CD for them. Retirement can last 25 or even 30 years, which means the old rules no longer apply. While higher interest rates have created new opportunities for generating retirement income, they have not changed the need for a thoughtful, long-term, diversified retirement income strategy.

Higher Rates, More Opportunities

In addition to higher CD and fixed rates, today’s higher interest rate environment has created several opportunities to consider when building retirement income strategies, including:

• Higher bond yields: it may sometimes make sense to lock in longer-term bonds rather than shorter-term bonds if you believe rates could be lower in the future.
• Dividend-paying stocks: companies that are doing well may offer higher dividend yields to remain competitive.
• Guaranteed income solutions: higher interest rates have also increased payout percentages on some insurance products with living benefit riders, SPIA’s and fixed annuity rates.

Even with these opportunities, it is important to avoid building retirement plans around the assumption that today’s interest-rate environment will last forever. Rates could be higher in the future, but they could also be lower.

Making Retirement Income Last

One of the key goals of retirement planning is making sure clients don’t outlive their income. Whether you use interest-bearing vehicles or longer-term investment vehicles, interest rates are only one part of a broader retirement-income strategy. The bigger challenge is creating a plan that attempts to provide sustainable retirement income.

With many retirees today living longer than previous generations, strategies designed to prevent clients from outliving their income are becoming increasingly important. For some, a secondary goal may be leaving assets to children or other beneficiaries. 

Achieving those goals requires advisors to address multiple forms of risk. Most clients tend to focus on market risk, meaning that if the market declines, they may have fewer assets available to support their retirement income needs. But they may need to pay attention to other risks too, such as inflation and reinvestment risk. For example, if a client buys a CD or bond and interest rates decline, they may not be able to reinvest at the same rate when that investment matures. As a result, future income could be lower than expected.

Another risk is sequence-of-returns risk. If the market declines significantly early in retirement and a portfolio drops substantially in value, continuing withdrawals can greatly increase the likelihood of running out of money over time.  

Diversification Remains Important

To help clients build sustainable income plans, advisors should continue to focus on strategies that address multiple risks and provide flexibility as market conditions change.

Diversification remains important. A client may be worried about the market and want to move everything into a CD paying 5%, but that may not be the best move because nobody knows what the market is going to do tomorrow or next year or 5 years from now. A cohesive retirement plan includes different pieces, such as different types of interest-bearing investments, equities and other appropriate strategies.

Having options is another essential consideration, and one way to build it into a retirement plan is by keeping enough emergency reserves in savings accounts, CDs or money market funds. Those assets can be used if the stock market is down or if an unexpected expense comes up. Clients may also need to adjust spending, withdrawal rates or income strategies depending on market conditions.

Another approach might be to cover fixed expenses with guaranteed income sources, such as pensions, Social Security or annuities and use income from variable sources, such as investment portfolios, to cover discretionary expenses. If markets or interest rates provide less income, clients don’t have to cut back on necessary expenses.

Guaranteed income solutions, particularly annuities with living benefit riders, have been a popular option over the last 20 years. They can help protect against sequence-of-returns risk because even if the account value eventually goes to zero, the insurance company will continue paying income according to the guarantees in the contract. They can also offer more flexibility, by providing opportunities for future income growth while preserving any remaining account value for beneficiaries, depending on the contract terms.

Keeping Clients On Track

One of the ways advisors add value is by helping clients avoid mistakes and stay focused on their long-term goals, not by finding the very best interest rate available. Higher interest rates have created new opportunities for retirement income planning, but they have not changed the importance of having a comprehensive plan. Clients can still become distracted by short-term market movements or today’s interest-rate environment. One of the most important things advisors can do is remind clients of their real objectives and help them stay focused on achieving them.