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Retirement Income and Low Interest Rates

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Low interest rates are hurting retirees trying to generate sufficient income from their savings to cover their living expenses. But a recent study revealed another concern for those who are currently working and still a decade or more away from retirement.

Obviously, for retirees who are depending a large part on their investment income, low rates have an immediate impact on their standard of living. And with little likelihood to add to their savings, they are at the mercy of financial institutions that determine how much interest they’re willing to pay their customers on their savings. With rates on bonds having fallen from around 4.5% five years ago to less than 1.5% now, this equates to about $250 less in monthly income for every $100,000 of savings.

For baby boomers and Generation Xers counting on long-term investment returns to help them get ready for retirement, this reveals an equally troubling problem. According to the study, 27 percent of those who would have had sufficient income to retire comfortably based on historical interest rates, now won’t earn enough income if low rates continue for the foreseeable future.

When the study looked at different income levels, the results varied a lot more. For low-income workers, interest rates don’t matter very much, because even under current conditions, only one in six of them has enough saved to produce sufficient income to cover their expenses. At higher income levels the impact gets larger, with the top half of income earners seeing declines of 17 percentage points in their retirement readiness.

One key question is how long low interest rates will last. When the study looked at scenarios in which temporary low-rate conditions gave way to higher rates in the future, the impact was far less severe. It also saw less extreme impacts when it incorporated other sources of income such as CPP, pension payments, and money from home equity.

In the past under ordinary scenarios, in the majority of cases a retirement portfolio could be preserved by withdrawing four percent annually. But simulations showed the failure rates soaring to 33 percent when bond rates equaled inflation, and 57 percent when rates stayed at their current levels below the inflation rate.

As challenging as it is to set money aside for retirement, studies like these highlight just how urgent the need is to do so to ensure a comfortable retirement can be counted on. Without adequate retirement savings, people could find themselves at the mercy of government interest rate policies over which they have no control over, or having to keep working longer than they want to make ends meet.
For those of us in retirement or facing retirement, there will be some tough choices to make. It means either putting significantly more money aside going forward, switching to more volatile equity type investments with higher growth potential, or working longer and retiring later than originally planned.

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