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The low interest rate environment created winners and losers. Many consumers have benefitted in the form of favorable mortgage rates, car loans and other borrowing tied to interest rates. Those with money in the stock market have been a big beneficiary. However, for that portion of people’s savings in conservative investments like CDs and bonds, interest rates over the past 10 years have been tepid as indicated in the chart below (the 10-year Treasury yield was 4.12% as of 11/9/22)
Source: Macrotrends
Fortunately, inflation stayed low at 2% or less until 2021 when rates jumped (see chart below). This has created a “bad news/good news” scenario, as inflation erodes purchasing power but has forced the hand of the Federal Reserve to increase the Federal discount rate. This results in higher interest rates, which helps conservative savers but hurts borrowers and the economy at large, hence the bad news.
Source: Coinbase Media Group
The good news for retirees came in the way of two large back-to-back cost-of-living adjustment (COLA) increases for Social Security of 5.9% for 2022 and 8.7% or 2023. Most importantly, the increase in interest rates – some would say normalization – as well as the large COLAs in Social Security means that advisors should be emphasizing the importance of maximizing Social Security benefits and discussing “lifetime income.”
Retirees and near-retirees should understand how deferring (and coordinating) their Social Security claiming strategy can significantly impact their standard of living in retirement. Certainly, Social Security has its funding challenges that will have to be addressed by Congress. But the 8% per annum increase for deferring Social Security past a person’s full retirement age (FRA) to age 70 should be thoroughly reviewed and considered.
The approach of deferring Social Security and using other funds if needed prior to age 70 is referred to as “bridging Social Security.” As Morningstar concluded in its recent whitepaper, even with the increase in interest rates for most retirees this approach will be optimal compared to purchasing a lifetime annuity like a single premium immediate annuity (SPIA). However, the increase in interest rates combined with the mortality credits inherent in lifetime annuities presents another retirement income avenue to be explored.
Committing a portion of retirement savings to a lifetime annuity for a healthy retiree (or one soon to retire) should still be considered. For example, for a 70-year-old male, a $100,000 SPIA from an A+ (Best’s rating) insurance company will generate $751 a month for life. Of course, inflation erodes the purchasing power of fixed annuities. However, advisors who take a holistic approach know that allocating 10%-15% of a person’s retirement savings to a lifetime annuity will allow the retiree to have an appropriate allocation to stocks to offset inflation over their retirement. At the same time, they’ll have ample guaranteed income and liquidity to meet expenses when the inevitable market dips occur from time to time.
Viewed in this holistic context, lifetime annuities in concert with allocations to stocks, TIPS, bond ladders and other diversified investments help retirees weather changing conditions regarding inflation and interest rates.
Given the political pressure on the Federal Reserve to bring interest rates back down before the economy slides into a recession, advisors should not assume that the current interest rate environment will continue indefinitely. To do so would be to the detriment of their clients, who could benefit from committing a portion of their savings to lifetime income.
Dave Evans is a frequent author and speaker in the areas of employee benefits, retirement planning and financial literacy. Prior to co-founding 401kSleuth LLC, Dave was the CEO and chief compliance officer (CCO) of a national trade association 401(k) Multiple Employer Plan (MEP).
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
Source: Macrotrends
Source: Coinbase Media Group
