Retirement Savings Penalized by Interest Rates

Bernanke to Spend Billions to Keep Interest Rate Low

The Federal Reserve decided yesterday to spend an additional $40 billion a month indefinitely to keep interest rate artistically low. The Fed pledged to keep interest rates low through at least the middle of 2014 and longer if necessary.

I watched Bernanke’s news conference after the announcement and he wanted to address the concern he is hearing that savers are being penalized by the artistically low interest rates.  He basically said that yes it does hurt savers but in his opinion it was more important to help create jobs and support the financial markets.

Some critics say that this action takes from financially conservative investors and retirees and gives to those who take on risky assets like stocks.  Some even think that the Fed is actually trying to force money out of savings with the low interest rates and into the stock market.  Somehow that is supposed to be good, but for whom.

Certainly not good for those nearing retirement or already retired and wanted to keep their money safe while drawing a fair return in the form of interest income.

“Who would have thought that 5-year CD rates I bought a year ago at 2% would turn out to be a good deal. Savers are screwed, while the spenders will continue to thrive on free debt. At some point this will balance out, but time is slowly creeping away and I’ll likely be dead by the time it does.”  Mark, retired.

Older Baby Boomers and Seniors are certainly upset that they are not getting any interest on their dwindling retirement saving; how many will have to put their saving at risk in this pumped up stock market or in an overheated bond market and maybe loose a big portion of their saving?

Senator Chambliss of Georgia’s office in DC called me to reply to this concern and said that the Federal Reserve is a private and independent and the Senator has no control or say so in this matter.  Wow, that is scary. Senator Ron Paul seems to be the only one concerned about the effect that these manipulated low interest rates hurts those who saved for retirement while helping the banks and encouraging risky investments.

Well I don’t know the remedy to this dilemma we have of getting no interest on retirement savings.  Some have moved their money to dividend paying stocks and municipal bonds to get a higher return, but at what risk?

Mark says in his quote above, at some point this will even out.  When and how?  In the meantime we wait.

For Safety Minded Retirement Savings the Certificate of Deposit (CD) is Still King

Retirement Savings – Safety

In saving money, safety has always had an opportunity cost; that is, lower rates of return than for instruments incurring greater risk.  Today, this is perhaps truer than ever at a time when so many are fleeting to safety.  So, how can we offer ourselves the greatest opportunity while we are obsessed more with the return OF our money than the return ON it?

Regardless of the trend of recent decades toward greater sophistication in retirement savings, the certificate of deposit, or CD, is still king.  The obvious advantage of the CD over traditional savings accounts is that they typically yield significantly higher interest; with the primary drawback being the commitment that one incurs to maintain the deposit for a specified period, usually from six months to five years.  The longer the term of the CD, the higher the associated interest rate.

So, how do we maximize growth in CDs while maintaining access to funds we need?  One common method is “laddering,” that is, purchasing multiple overlapping CDs with maturity dates spread out so that funds are made regularly available without having to suffer the lower rates associated with shorter terms.  Today, however, we have the added concern that interest rates are so low that the added interest of a longer term is possibly not worth the risk of having the money obligated when rates go up.

Shopping for CDs is a balancing act; weighing the available rates against the obligation of the time deposit.  To add complexity to the decision, penalties for early withdrawals vary significantly between banks.  The penalty for withdrawing early from one bank may be quite stiff, while another bank may only penalize the account a small portion of the interest earned, often as little as one month’s interest.  Especially today, comparing penalties is a critical part of CD shopping.

So, what are the alternatives to the certificate of deposit?  In an effort to retain old depositors and woo new ones, banks are occasionally offering high yield savings or money market accounts with interest rates comparable to CDs, but with complete liquidity.  It is wise to keeps one’s eyes open for offers like this, but one must be wary of limitations and fine print.

Finally, there is the old reliable fixed annuity, offering usually higher interest than CDs, tax deferral, and sometimes greater liquidity.  While fixed annuities have traditionally had greater surrender penalties and poorer liquidity than CDs, to remain competitive, more recent products have been known to offer immediate withdrawal of principal at any time without penalty.  If a more suitable alternative is found early on, one can just pull out the funds and start over.

It is important not to lose sight of the power of tax deferral.  As of this writing, rates for many annuities were hovering around 2.75%.  Because of the effects of tax deferral, a taxable CD would have to earn around 3.7% on average to keep pace, while 5-year CD rates are currently averaging 2.26%, per  Where appropriate, annuities can be laddered as well (provided of course that the annuitant has not established a guaranteed income stream).

In this season of challenging savings interest rates, it pays to compare carefully, including more than just interest rates in this comparison.  As always, it is wise to involve a qualified financial planner or advisor in this decision; and bear in mind that the term “qualified financial advisor” typically does not describe anyone employed within your local bank branch.

My name is Rob Drury, and I am the executive director of the Association of Christian Financial Advisors, headquartered in San Antonio, TX.   The ACFA is the nation’s largest nonprofit financial planning network.

Additional source: Financial Planning in Retirement