Low interest rates have made life a lot easier for many borrowers struggling to make monthly payments. But for retirees, who have to live off their portfolios, low rates have caused huge problems.
A May survey from Gallup and Wells Fargo (WFC) confirmed what many people already know all too well: Low interest rates are destroying people's confidence about ever being able to retire. Fully one-third of those surveyed said that they expect low rates will compel them to work longer and delay their retirement, while 45% of current workers say they think low rates will make it a lot more likely that they'll outlive their money after they retire.
In particular, the survey points to deteriorating confidence among retirees. Last year, retirees were much more optimistic about their futures. Yet with core inflation outpacing rates on bank certificates of deposit by more than a factor of three in many cases, those living on fixed incomes are feeling the pinch -- and will continue to do so as higher prices reduce the purchasing power of their nest eggs.
To fight low rates, some retirees have taken drastic measures to fill their income gaps. Almost 20% of retirees have moved their money into riskier investments they probably wouldn't have bought if rates weren't so low. For instance, some retirees have turned to dividend-paying stocks, many of which pay out more income than bank CDs and other income-generating investments.
No single investment, however, is a perfect solution for income shortfalls. The best answer for most retirees involves using a combination of investments to generate income. Dividend-paying stocks may play a role in your portfolio, but putting all your money into stocks involves far more risk than the vast majority of retirees can afford to take.
How to Stop Low Interest Rates From Ruining Your Retirement
There's a persistent assumption going around about what happens after one retires: Pundits, financial planners and even retirees often claim that your spending shrinks after you leave the 9-to-5 world.
Sure, your house may be paid off by then, and you may be able to ditch the expenses of commuting and buying clothes for work. That's not the full picture, though.
In good and not-so-good ways, many people end up spending more than they expect during their golden years.
For lots of folks, retirement means finally getting around to doing things you've been putting off for years. And those things cost money.
You may finally do some traveling in Europe, for example, or explore the U.S. in an RV. Want to get serious about your love for curling? Joining a league costs some money. Looking forward to overhauling the garden or taking up woodworking? That'll cost you, too. Even just traveling to visit and spend time with the grandkids can add up -- in travel costs, dinners to treat the family, and gifts and ice creams for the young ones.
Of course, you don't have to bear these costs. You can let the children and grandchildren come to you and can spend more time in public libraries than on golf courses. But the early years of retirement, in particular, are when folks tend to have significant energy and lots of plans.
Unfortunately, many expenses in retirement are not so discretionary.
Health care, for example, can take a huge bite out of your nest egg. Fidelity Investments recently estimated that a 65-year-old couple retiring today can expect to pay, on average, about $230,000 on health care. That's just an average, so you might spend far less -- but you could also spend much more.
Medicare probably won't provide sufficient coverage, so you might need to buy supplemental insurance, which isn't usually cheap.
Meanwhile, though a lower income level will probably mean your income taxes will decrease, you'll still be on the hook for property taxes. And those will probably keep growing over time. If your annual property tax is $3,000 and it grows at 3% each year, it will hit $5,400 in 20 years.
Your home insurance costs will rise, too, along with your car insurance premiums, the cost of heating and cooling your home, groceries, and most other items.
And finally, whereas you might expect retirement to be a time when you're no longer raising children and supporting those dependents, you might still find yourself occasionally -- or routinely -- helping your loved ones out financially.
Still, the news isn't all bad. While you might spend more than you expected to once you retire, you probably won't keep it up. As we move into and then out of our 70s, people tend to slow down and be less active. Less travel, less eating out, and fewer hobbies can mean lower spending.
Throughout most of our retirement, we'll enjoy discounts on various expenses, too, such as movie tickets, meals, and even property taxes.
What to do
Don't let your retirement plan end up designed by assumptions you never questioned. Take some time to map out what your expenses may be in retirement, and to make sure you're saving, investing, and accumulating enough to support them.
Another possibility is working part-time through part of your retirement, which can add income and possibly some useful benefits as well. It also keeps many retirees happier, giving them a social setting to belong to. Downsizing to a smaller home or moving to a less costly town or region can also make a difference.
Spend some time planning now, and you'll thank yourself later.
Instead, consider other types of income-producing investments. Municipal bonds earn interest that isn't subject to federal income tax, but they also have higher yields than Treasury bonds of the same maturity -- even though you have to pay federal tax on Treasury income. Meanwhile, managed payout funds make fixed payments to their shareholders over time, and even if the income the fund portfolio generates isn't enough to cover a payment, the fund can go in and essentially return a portion of your investment back to you to cover your cash flow needs.
These low interest rates won't last forever. But while they do, make sure to do what you have to in order to ensure you have the income you need.
Motley Fool contributor Dan Caplinger is trying to put low rates on his side. You can follow him on Twitter here. He doesn't own shares of the companies mentioned. The Motley Fool owns shares of Wells Fargo. Motley Fool newsletter services have recommended buying shares of Wells Fargo.