This catchy marketing phrase coined by ING has taken an interesting and horrible new twist for current retiree’s trying to live off the interest generated from bonds and other fixed interest investments. Unfortunately, “your number” is a moving target based on several key variables, some of which you cannot control. We can control our spending, but inflation and interest rates are out of our control and they are a huge factor in our retirement planning.
Low Interest Rates Have HUGE Impact on Retirement
I met with one of my favorite retired couples this week. They have always invested a good percentage of their retirement savings in CD’s. The wife is my best local CD rate resource. I asked her what the going rate is on a 5-year CD. She told me 0.4%. O.4%, are you kidding me? That is only slightly better than what you receive for putting money under your mattress. Look at the charts below to see how much income you could expect to receive today as compared to five years ago from a 5-year CD.
5 yr. CD
Annual Interest$10,000 .4% $40 $100,000 .4% $400 $1,000,000 .4% $4,000
5 yr. CD
Annual interest$10,000 4% $400 $100,000 4% $4,000 $1,000,000 4% $40,000
The federal government’s easy monetary policy has driven interest rates down to infinitesimally small numbers driving 5 year CD down 10x from where they were just 5 years ago!
As I run numbers for my clients to compute how much money they need to have saved for retirement, it always “depends on the return" we assume from their fixed income (bonds & CD’s). As you can see from the chart below this number has been trending downward for the past thirty years.
Imagine if you were a senior citizen and retired ten years ago with a one million dollars invested in CD’s that were paying four percent or $40,000 per year and now, ten years later, that same $1,000,000 invested in a five-year CD is only generating $4,000. How are they supposed to live on this? One million dollars may have been “your number” ten years ago, but not that won’t cut it.
What can someone in this position do to counteract low interest rates?
- Invest for total return rather than fixed income. This means creating a balanced portfolio containing many different asset classes that are not overly correlated. Ideally, the portfolio will grow at a 4-5% rate (the principal will fluctuate) and you can set up an automatic withdraw from your portfolio to be made into your bank account.
- Use low-interest savings accounts to pay off debt. Consider paying off your mortgage or car loans. Anything that reduces your monthly cash flow need will help. If you are a ways away from retirement, I would strongly suggest refinancing your mortgage and have the period of years until payoff meet your retirement age goal.
- Consider creating a “private pension”. A pension is created by simply giving a lump sum of money to an insurance company and they offer a guaranteed payout of your principal with interest for a period of time that could be your lifetime or a joint lifetime if you are married. The advantage of doing this is that you can spend and enjoy the principal from your retirement nest egg WITHOUT THE FEAR OFF OUTLIVING IT.
For example, a 70-year-old woman creating a $1,000,000 private pension (annuity) could receive a monthly income of $5,700/month ($68k/year) for as long as she lives. Under this example, the contract ends when she dies. If she was concerned about dying before she received her principal back as income she could take $5,262/m. and if she died before getting her money back the difference would be returned to her beneficiary. There are many payout options including having the payment continue to her spouse if he survived her.
In summary, times are tough for many people these days and seniors living on a fixed income have it tough. If I was a senior citizen, low-interest rates would be a much bigger reason to be upset with our Government that potentially higher Medicare insurance costs.
If you need some advice regarding any of the three strategies (total return portfolio, refinancing or creating a private pension) feel free to contact our office.
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