How To Retire Despite Low Interest Rates

retirement-exit-2My Comments: Don’t expect interest rates to increase anytime soon.

Decisions by the Fed will influence the prevailing level of interest rates but in the background is the everpresent supply and demand curve. This simply states that the price being paid (interest rate) is a function of how much there is available compared to the demand for whatever is being sold.

Right now there is a ton of money in the system. Many would argue there is too much and the Fed screwed up. But it is what it is and until either the demand increases or the supply shrinks, you’re going to see historically low interest rates.

by Doug Carey, Owner and President, Wealthtrace

Interest rates are extremely low, which is bad news for those who have been planning to have a fixed income in retirement. Ten years ago, the yield on ten-year Treasury bonds was above 5%. Today it sits at 1.8%, which is below the rate of inflation.

Low Interest Rates Have Made It Tough For Retirement Plans
Many of us can remember how our grandparents and parents lived off the income that came from bonds in retirement. Before rates decreased so much, less money was needed in retirement. I’ve written before about how much money it takes to retire comfortably. Just how difficult can it become to live off of treasury income in retirement today compared to just a few years ago?

Case Study
I shared this analysis in our WealthTrace financial planner using a case study of a retired couple aged 65. Their entire investment of $500,000 is comprised of ten-year Treasury bonds in IRA accounts. My other assumptions are that their annual Social Security payments will be $30,000 and that their yearly expenses will total $45,000 (not including taxes). Lastly, inflation is 2.5% in my case study and this couple is counting on living until age 95.

When I ran this analysis, my goal was to find out whether this couple’s retirement savings would run out, and at what age it would happen. I then wanted to compare that to the time when interest rates were much higher and the yields from Treasury bonds were 5%.

I did indeed find that our couple would outlive their money in retirement in today’s environment by the age of 80. Some might say, “They probably won’t live until 80!” But the odds are nearly 50/50 that they will. So, something has to change with their plan.

What did we find if interest rates were back to the 5% level? We found that the couple would have money in the bank until age 100, which would provide for any unexpected costs.

And what happens if interest rates rise to 6%? Their money would hold out until the ripe old age of 105.

The Past And The Present
There is not much use in talking about what could have been. The fact is that interest rates are incredibly low today. The question is, how do we change the situation for our couple? What if they had aimed to have their retirement savings last until age 100? I used our financial planning tool to run some scenarios and put together some ways they can make this happen: 1) They can reduce their expenses by $5,000 per year or 2) They can work part-time for another fifteen years, earning $35,000 per year. Most people will give a big thumbs-down to such ideas.

What if instead we get them out of their low-yielding Treasuries and into solid dividend-paying stocks? I’m not talking about just any old dividend payers. We want those companies with a history of increasing their dividends year in and year out. So, I moved a third of their funds into dividend growth stocks that have a history of paying and growing dividends over time.

I normally only recommend and invest in companies which yield dividends above 2.5% and a solid history of increasing their dividends over time, even in recessions. Three of my favorites that meet these criteria are Johnson & Johnson (NYSE: JNJ), Coca-Cola (NYSE: KO), and AT&T (NYSE: T).

Following this strategy, we could move a third of our couple’s money into a basket of reliable dividend payers like the three companies I mentioned. What difference would this make to their savings? It turns out that at age 95 they would have about $20,000 left. If we move half of their money into these companies, they would have $60,000 left.

Bonds Will Not Be Enough For Most
This analysis shows that bonds will not suffice for most people planning for retirement. It also shows that a) Retirees need to overcome inflation – if their income is less than the inflation rate, they are fighting a losing battle each year, and b) The power of growing dividends over time can have an immense impact on a retirement plan.

It’s a rough world for retiring these days with interest rates so low, but there are other options to the usual savings methods. Using solid dividend-growth stocks for income in retirement can make all the difference.

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