Many people plan to live on the interest income from their investments during retirement. But in a down economy, the Federal Reserve is keeping short-term interest rates near zero. While that is good news for borrowers, it is bad news for retirement spenders.
For example, CDs and money market accounts pay only .25 percent to .5 percent interest. On a $10,000 investment, that amounts to $25 to $50 per year in interest income. A few hundred thousand dollars would earn only a few thousand dollars of interest at best. What can retirees do in this situation? Consider the following based on your situation:
1. Pay off any high interest rate loans, like credit card balances and auto loans. Eliminating loans with rates of 10 percent or higher will save you hundreds or even thousands of dollars of interest each year. Less money going to interest payments means more money in your pocket for living expenses.
2. Look into U.S. Treasury bonds. Examine whether an investment in three- to seven-year U.S. Treasury Bonds might yield higher interest than any CDs you own. Assuming you hold these bonds until they mature, you can pick up an extra 1 to 2 percent in interest rates with very little risk. You can buy U.S. Treasury bonds through your bank or from www.treasurydirect.gov.
3. Be careful about investing in long-term CDs, like 10-year CDs. If the economy recovers and begins to grow normally, interest rates will rise. You do not want your money locked into lower, long-term interest rates from earlier years.
4. Beware the temptation to chase riskier investments in hopes of earning higher returns. Stock investments, for example, sometimes can pay off in a big way. Remember, however, that a promise of a greater return means higher risk as well. Be careful about investing in a “sure thing” that promises a safe investment with higher income. If you do not thoroughly understand how an investment works, walk away.
5. Choose high-quality companies with a history of strong dividend payments if you are considering investing in the stock market. The dividend yield on some stocks is as good as or better than the current income from government bonds.
6. Invest in immediate annuities with care, as low interest rates bring special considerations. The income paid by an annuity is tied to the current interest rates, so you may want to wait to buy an immediate annuity until interest rates are higher. If you buy an immediate annuity when interest rates are low, you will lock in a low annuity payment for your lifetime. To protect yourself, you can create a “ladder” of immediate annuities by buying one now, then another one in a year when interest rates have changed, and so on over time. By taking this approach, you can lock in a range of interest rates on immediate annuities, rather than just one potentially low rate. Because this can be a complex approach, it is wise to consult a financial adviser.
7. Consider a reverse mortgage. If you are older than age 62 and have carefully considered a reverse mortgage on your home in the context of your overall retirement strategy, a period of low interest rates may be a good time to take out a reverse mortgage because the interest building against your home will grow more slowly. To qualify for a reverse mortgage, your home will need to be nearly debt-free. Even if your home has dropped in value over the last few years, as many have during the recession, you may still have tens of thousands of dollars in equity in your home that you can borrow against.
© 2012 National Endowment for Financial Education. Used with permission. All rights reserved.