How the Government Is Making It More Painful for You to Retire

Higher long-term rates make fixed annuities more attractive. Pre-retirees had a good thing going--until the Fed decided not to curb its stimulus program.

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As the Fed has toyed with “the taper,” pre-retirees have gotten a clear lesson in how important interest rate movement is to their future financial security.

The taper, of course, refers to the gradual removal of Federal Reserve stimulus—most notably the monthly purchase of $85 billion of mortgage and other bonds. The Federal Reserve has been running this program since the financial crisis in order to keep long-term interest rates low.

The Fed has been hinting at a shift in policy since spring but so far has not altered its course, and the on-again, off-again plan to tighten the spigot has led to some big swings in key rates. The 10-year Treasury bond yield soared from 1.7% in early May to 3% by early September.

When long-term rates move substantially, so does the cost of guaranteed lifetime income purchased through a fixed annuity, which is an increasingly popular insurance product. As traditional pensions have disappeared and Social Security benefits have eroded, financial planners have moved clients into fixed annuities to provide income to cover expenses like rent and utilities in retirement.

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The surge in long-term rates was welcome news on this front. Short-term rates didn’t follow suit, leaving bank CDs and money market accounts with continuing pathetically low yields. But as long rates rose fixed annuities got cheaper, meaning that it cost less to secure the same amount of guaranteed lifetime income.

At the end of June, a 60-year-old planning to retire at 65 and live off a fixed annuity could have bought $1 of annual income for $16.34, according to BlackRock’s Cori index. By early September the same person could have bought $1 of annual income for just $15.48—almost entirely because long-term rates had risen and offered new investors a healthier, secure yield.

Is that a big deal? Look at it this way: If this 60-year-old had $250,000 to purchase a fixed annuity, it would have bought $15,300 of guaranteed annual lifetime income in June. By September, it would have bought $16,150 of guaranteed annual lifetime income. That additional $850 was a gift from the Fed, which essentially faked the markets into thinking that higher long-term rates were imminent.

Alas, since early September the Fed’s rhetoric has reversed. Recent employment and housing data suggest the economy is still struggling. Maybe the bond purchases will go on unabated into next spring, at least. Long rates are falling again and that $1 of retirement income costs about what it did back in June.

So what’s the point of this exercise? If you are nearing retirement, say aged 55 to 64, and planning to buy a fixed annuity to augment your income it pays to keep an eye on long-term rates. As they rise so does your ability to lock in greater future income, no matter what happens later on.

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Despite the spring surge, long-term rates remain historically low and that makes fixed annuities historically expensive. You see what a difference higher rates can make, so consider waiting if you can before buying a fixed annuity. Rates will rise in time, though no one knows how soon or for how long. The closer you get to retirement, the more important it is to lock up guaranteed income after long-term rates have moved higher.

7 comments
aaroncavanaugh
aaroncavanaugh

Hi, Thanks for writing this article. I thought The Fed wasn't government technically. Why would poor and middle class people ever invest in the market? You make it sound like people are rational and so is the market. My feeling is that unless you have a ton of excess money (aka the top 1%) you tend to spend it to keep up with the Jonses. If people reach retirement when the market is down they may have no retirement. Pensions are a better system than 401k for almost everyone except for the top 1%. Thanks for teaching me about the word taper. Thanks. God bless. Aaron

Hotpuppy
Hotpuppy

So here's the fun part... if you buy an annuity like the one mentioned, you are betting you will live past 76.  It takes 16.33 years for the $15,300 return to pay back.  If you don't expect to live longer than 76 it makes more sense to keep the cash.  Of course, to play this game you have to have the $250K to start with.  Maybe you had a 401K that wasn't raped by fees and pillaged by banksters.  Alternately, you could take your $250K and find an investment that pays 6.12% interest annually.  You'd make the same return.  If it was me, and I had $250K I'd look at crowdfunding and microlending as a way to diversify risk and achieve return.  

mary.waterton
mary.waterton

The Fed "taper" is the biggest head fake of all times. There will be no taper for years to come. Printing money robs from the poor and gives to the rich by means of inflation. Exactly who did you think was bailing out Wall Street? The poor. It's always the poor.

roy.brander
roy.brander

I'm part of a very large pension plan (~200,000 enrollees) that went down to 80% funded, mostly because of the Crash, partly because pensioners are living longer.  It recovered a bit after the Crash as the stock market rose, but your safe, long-term bonds are in the basement because of the government cash infusions.   After 5 years, still around 80%.

Well, yoicks.   Government stepped in and basically demanded they cut future benefits.  Their point: we can't expect the market to save us.  Just because it went way down, doesn't mean we have any "up" coming.

Which I interpreted this way: Wall St. found they could make a profit trashing investments - faking up the value of their products, selling, being gone by the time they crashed.  And government responded by paying it back out of pension funds.   Not taking money from them directly, of course - but by inventing and lending vast sums of cash to the banks for cheap, it sentenced millions of ordinary workers to paying more for their retirement.   Banks get richer, prospective pensioners get poorer.

And the local government realized that and also that there was no bank reform in the offing: it can, and almost certainly will, all happen again.  So they had to acknowledge that pension funds will not in the forseeable future earn as well as they did in times of tighter banking regulation, and benefits must be reduced.

It's nice if this particular crisis - SEVEN years after it first hit in late 2007 - will finally see a slight increase in prime rate in 2014; but the respite is temporary and retirement planning remains more difficult than it was for fifty years.

NamecNassianer
NamecNassianer

"How the government is making it more painful for you to retire"?

Only if "you" intend to purchase annuities.  So don't purchase annuities.

Still, I guess you had a deadline to meet and you had to write something.  Sorry I took time to read it, though.


bojimbo26
bojimbo26

Can't read the article , advert right in the middle .

tom.litton
tom.litton

@mary.waterton Inflation has been below the Fed's target (of 2%) since 2008.   So, no actual robbing has taken place.


On the flip side, it really helps all those poor people that stretched their income to buy a house and then lost their job.  It fuels the housing market, increasing their home value, and allows them to refinance at cheaper rates (although access to those loans are still a bit of a problem).