Three Ways Rising Interest Rates Could Affect Your Retirement
Life + Money

Three Ways Rising Interest Rates Could Affect Your Retirement


Higher interest rates are on the way, which could be a game changer for retirees.

The Federal Reserve is looking to raise short-term interest rates, which have stayed close to zero since December 2008, following the aftermath of the financial crisis. 

While the timing of the Fed's rate hike is still up for debate, retirees will feel the affects of higher interest rates in these three ways.

1. Fixed Income

Rising interest rates threaten bond values, as prices and yields move in opposite directions. 

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Retirees holding bonds run the risk of losing principal as interest rates rise, should they sell their bonds before they mature.

"Most retirees hold substantial amounts of bond mutual funds in order to be more conservative and these could potentially lose principal as rates rise," said Paul Taghibagi, senior partner at Los Angeles-based Signature Estate and Investment Advisors.

That's especially troublesome if the fund managers sell the bonds before maturity. 

"The better alternative in an environment like this would be to directly own a ladder of bonds with staggered maturity dates," he said. "Bonds do not lose principal as long as they are held to maturity, and the bond holder collects coupon interest along the way."

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This way, you're in the driver's seat when it comes to buying and selling bonds, rather than relying on a fund manager. 

That said, higher rates allow retirees sitting on the sidelines to move deeper into fixed income investments for a bargain, while enjoying higher coupon payments. 

"Retirees will be able to buy individual bonds at a cheaper rate and get a higher return," said Susan Garland, editor of Kiplinger's Retirement Report

Garland suggests bonds with shorter durations, which are less sensitive to changes in interest rates. 

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Keep in mind, many economists think the Fed will gradually raise interest rates over time. 

2. Long-Term Care Insurance 

Believe it or not, rising rates even extends to long-term care insurance. 

That's because the premiums paid each month to the insurance company are usually invested in the bond market. 

"When rates dropped, the insurance companies had to raise premiums for policy holders to make up for the declines in the bond market," Garland added.

Related: Why a Market Crash Could be Good for Retirement Savers

Remember, rising rates is bad for bonds.

"Now what you'll be seeing is, when rates rise, it's likely that those premium increases will slow down or be eliminated," Garland said. "So if you're buying a policy today, you can be a little bit more confident that your premiums won't increase for a numbers."

3. Bank Accounts 

With record low interest rates, returns on savings accounts and certificates of deposits plummeted. A one-month CD yields 0.15% on average, according to RateWatch, a subsidiary of TheStreet.

That has caused investors to flood the stock market, in favor of higher returns. But with those returns, comes extra risk. 

"We've seen a lot of clients extend themselves in this zero interest rate environment, taking on a lot more risk than they normally would to generate income," said Brian Rehling, co-head of global fixed income strategy at Wells Fargo Investment Institute, based in St. Louis. "As interest rates slowly rise, investors should be able to dial back that risk," and move some money out of the stock market into safer investments like CDs.

While experts say the increase in rates on savings accounts and CDs won't be immediate, retirees looking for higher rates in these savings vehicles "will eventually find them," Garland added.

This article originally appeared on Main Street.
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