Making Your Money Last

What Happens to Your Retirement Plan Now That the Fed Lowered Interest Rates?

As you design your retirement income plan, you might think that the Fed's cut in interest rates will force you to switch gears. But remember: Whether it's dividends, interest or annuity payments, don't try to time the market.

News from the financial world has been confusing lately. Is the economy strong or about to bust? Is the inevitable recession close or still years off?

At the end of July, the Fed lowered its key interest rate by 0.25% to just below 2.25% — the first time it has cut rates since 2008. But what does that mean for your retirement, particularly for new retirees who are ready to set up their retirement income plan and make other lifestyle decisions?

These new retirees for the most part have seen 401(k) and IRA balances grow. But now they must convert retirement savings to income. For them, the question they often ask is, “Do I set up my plan now or wait until interest rates go back up?”

My answer:

When it comes to retirement income planning, don’t try to time the market. Set up your plan with the flexibility to change, and in turn gain the peace of mind to stay the course.

My planning method is based on Income Allocation and includes annuity payments in the mix. I often have conversations with advisory clients who are attracted to annuity payments as a source of secure lifetime income; most, however, want to buy when 10-year Treasuries are peaking. Sure, it’s nice to imagine earning the top rates on everything, but as you will see, that doesn’t usually work. And it’s not necessary.

At the end of November 2018, 10-year Treasuries were at 3.24%. As of Aug. 2, 2019, they sat at 1.86% — or more than a 40% drop. People who were thinking last fall that they would use up to 30% of their savings to purchase annuity payments are disappointed. Because they waited, they’re going to have to revise their plans or reduce their budget. Or so they think.

They may not be worse off. Here’s why.

A typical couple adopting my Income Allocation plan would be looking at income coming from a combination of dividends, interest, annuity payments, withdrawals and Social Security payments. So, is the income from their plan now higher or lower than the plan they would have adopted in November? It’s higher, for the following reasons:

  1. The value of the newly retired couple’s balanced (50/50) portfolio of stock and bond indices increased by over 7% during the period, giving them more savings to apply to the annuity purchase and other sources of income.
  2. Payout rates for income annuities do not follow interest rates directly. In fact, while 10-year Treasury rates went down more than 40%, Payout rates went down only 4% to 5% (we explain why in the next section). Also, the taxable portion of annuity payments in the newly retired couple’s portfolio fell by up to 50% during the period, reducing their overall projected tax bill.
  3. Since under my Income Allocation plan they are not as dependent on the interest on low-risk, fixed-income investments (which they would be if they held only Treasuries) they are less affected by the lower interest rates.

Putting all those elements together, an Income Allocation plan could support more income than back in November, despite lower interest rates.

Of course, not every eight-month period will operate with falling interest rates and an improving stock and bond market. My point is that when all of the financial elements of a plan are priced at the market (and income annuities are typically priced biweekly by annuity carriers to reflect current annuity crediting rates) then the key driver is how to bring those elements together in a plan to work for the consumer.

How annuity payments are calculated and set by insurance companies

To see why annuities aren’t directly affected by what the Fed does with interest rates, you just have to look at how their payments work. Annuity payments are made up of three components:

  • Interest credits. These are guaranteed by an annuity issuer for the life of a contract. That interest rate is generally set every two weeks for new contracts. (Once you buy a contract, that annuity crediting rate is set for life.)
  • Return of principal. A portion of each payment is a small slice of the initial payment you made.
  • Survivor credit. In the simplest terms, your annuity contract is pooled with other income annuity purchasers. You get credit if you survive. For new contracts, those credits may be reviewed every few years. That amount doesn’t change with market interest rates.

As you can see, two of the elements change very seldom if at all. The annuity payout rates do change because of changes to annuity crediting rates. While the Federal Reserve’s actions affect short-term interest rates, there is no direct correlation to how annuity companies invest or how they price income annuities.

Build your retirement plan around income, not assets

An income allocation plan differs from asset allocation in that you create a plan designed for lifetime income with less market risk. Annuity payments replace a portion of the fixed income portion of your investment portfolio to provide guaranteed income for life. Not only does replacing bonds with annuity payments mean you don’t have to follow the ups-and-downs of the market, it also means you can be more aggressive, if you wish, in the stock portion of your plan.

On top of that, income annuities purchased out of personal savings offer benefits from the IRS that you won’t get from other fixed-income investments. The portion of your annuity payment that is a return of principal comes to you tax-free. While interest payments from municipal bonds also are tax-free, income annuities can help decrease your overall tax rate and offer better returns, as this article explains.

So, when building your plan for retirement income, consider annuity payments — whatever the Fed does now or in the future.

About the Author

Jerry Golden, Investment Adviser Representative

President, Golden Retirement Advisors Inc.

Jerry Golden is the founder and CEO of Golden Retirement Advisors Inc. He specializes in helping consumers create retirement plans that provide income that cannot be outlived. Find out more at Go2income.com, where consumers can explore all types of income annuity options, anonymously and at no cost.

Most Popular

Where's My Refund? How to Track Your Tax Refund Status
tax refunds

Where's My Refund? How to Track Your Tax Refund Status

If you're waiting for your tax refund, the IRS has an online tool that lets you track the status of your payment.
March 2, 2021
Where's My Stimulus Check? Use the IRS's "Get My Payment" Portal to Get an Answer
Coronavirus and Your Money

Where's My Stimulus Check? Use the IRS's "Get My Payment" Portal to Get an Answer

The IRS has an online tool that lets you track the status of your stimulus checks.
February 19, 2021
Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021

Recommended

33 States with No Estate Taxes or Inheritance Taxes
retirement

33 States with No Estate Taxes or Inheritance Taxes

Even with the federal exemption from death taxes raised, retirees should pay more attention to estate taxes and inheritance taxes levied by states.
February 24, 2021
18 States With Scary Death Taxes
inheritance

18 States With Scary Death Taxes

Federal estate taxes are no longer a problem for all but the extremely wealthy, but several states have their own estate taxes and inheritance taxes t…
January 24, 2021
Are There Cracks in Your Pension Plan?
retirement

Are There Cracks in Your Pension Plan?

You're counting on pension benefits in retirement. But how secure is your pension plan? We offer some guidance, including a pension calculator, to hel…
December 28, 2020
Doug Glanville on Race, Sports — and Personal Finance
personal finance

Doug Glanville on Race, Sports — and Personal Finance

Kiplinger contributor (and former Major League Baseball player) Doug Glanville shares insights from years playing the game — and investing. Also, what…
December 22, 2020